Chapter 35

Chapter 35 discusses the Phillip curve which describes the negative relationship between inflation and unemployment.  When aggregate demand is expanded, policymakers can select a spot on the Phillip curve higher inflation and lower unemployment. Policymakers can also do the opposite, contracting the aggregate demand and selecting a point with lower inflation and higher unemployment. Thus, through this operation, one can see that there is a trade off between inflation and unemployment. However, this conclusion only holds in the short run. In the long run, the expected inflation adjusts to what occurs in the actual inflation. Thus, the long run curve is vertical at the point of natural rate of unemployment. Changes in aggregate supply can also shift the Phillips curve. An adverse supply change gives policymakers a worse trade off than before between inflation and unemployment. They have to accept a higher rate of inflation for any given rate of unemployment or higher unemployment rate for any given inflation rate. In essence, it becomes out of the policy makers' hands and they have to decide based on what they are given. If the Fed decreases growth in the money  supply to reduce inflation, the economy moves along the short run Phillips curve. This results in temporarily high unemployment. The cost to deflate the economy depends on how fast the expectations of inflation fall.