THE LAST CHAPTER

Chapter 35 is about the short run trade-off between inflation and unemployment. The Phillips curve is the short-run relationship between inflation and unemployment. This idea was first published in 1958 by A.W Phillips in an articled titled "The relationship between Unemployment and the Rate of Change of Money Wages in the United Kingdom". He showed a negative correlation between  the rate of unemployment and the rate of inflation: years with low unemployment tend to have high inflation and years with high unemployment tend to have low inflation. The natural rate of unemployment depends on various features of the labor market (minimum wage laws, market power of unions, etc). The inflation rate depends primarily on growth in the quantity of money controlled by the Fed. Paul Samuelson and Robert Solow reasoned that this correlation arises because low unemployment was associated with high aggregate demand which in turn puts upward pressure on wages and prices throughout the economy. The Phillips curve simply shows the combinations of inflation and unemployment that arise in the short run as shifts in the aggregate-demand curve move the economy along the short-run aggregate-supply curve. An increase in the aggregate demand for goods and services leads, in the short run, to a larger output of goods and services and a higher price level. Larger output means greater employment and thus a lower rate of unemployment. Shifts in aggregate demand push inflation and unemployment in opposite directions. If policymakers expand aggregate demand they can lower unemployment but only at the cost of higher inflation. Contracting aggregate demand they can lower inflation but at the cost of temporarily higher unemployment. In the 1960's, however, it was concluded that inflation and unemployment are unrelated in the long run. . The long-run Phillips curve is vertical at the natural rate of unemployment. Monetary policy could be effective in the short run but not in the long run.