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Inflation: Effects on Unemployment and Productivity Growth

Inflation: Effects on Unemployment and Productivity Growth

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5. Inflation: Effects on Unemployment and Productivity Growth



• 5b. The Friedman-Phelps natural rate argument

showed that the Phillips curve was a short-run

relation. In the long run, the Phillips curve is

vertical at the natural rate, as indicated by Figure

22.9.



5c. Inflation affects investment and technological

change because it affects the level of uncertainty

about relative prices, in particular, uncertainty

about future real returns. A similar argument holds

for technological change.



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5. Inflation: Effects on Unemployment and Productivity Growth



5d. In many countries governments resort to

printing money to finance expenditures,

resulting in an inflation tax. This is not true

for the United States, so some other reason

for persistent inflation must be found.



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5. Inflation: Effects on Unemployment and Productivity Growth



5e. One explanation is that the measures of inflation

are biased due to the method used to compute price

indexes. This is true for the CPI because it relies on

a base-year quantity to construct the index. When

the price of a good rises, substitution occurs so that

the quantity of the higher-priced good falls. But the

quantity of the good is fixed at the base-year value,

lending a bias to the index. This bias is about 2

percentage points. So at 2 percent inflation based on

the index, actual inflation is close to zero.



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5. Inflation: Effects on Unemployment and Productivity Growth



• 5f. Concerns about disinflations needed to

reduce high inflation reflect the short-run

costs associated with the policy, namely,

high unemployment. So even if low

inflation is a good long-run policy, if

policymakers place emphasis on the shortrun costs, they will not pursue disinflation.



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