Explain the difference between the short run and the long run Phillips curves.?

Question

What is the role of inflation expectations in moving from the short-run to the long-run?

Answer 1

Phillips curve

Is a curve depicting the relationship between inflation and unemployment. Inflation only effects the rate of employment when inflation was not expected. When you have higher and expected inflation for example, firms believe their products are commanding a higher price relative to other goods and so they increase output by hiring more labor. Lower inflation means firms think their products are cheaper relative to other goods so they reduce output increasing unemployment.

In the short run expectations can vary and be incorrect. So the government can for example, increase the supply of money which raises inflation and thereby reduce unemployment and increase real GDP.

In the long run, however, there is no relationship between inflation and unemployment because people adjust their expectations so a government that keeps trying to increase inflation to reduce unemployment will find that individuals and firms will adjust their expectations accordingly so that there will be no real effect only a nominal one.