It's often claimed

that macro policy makers

especially monetary policy makers

face a trade-off

between inflation and unemployment.

The idea is that

expansionary monetary policy can boost output

which lowers unemployment

but raises inflation.

Likewise, contractionary monetary policy

can lower output

which raises unemployment

but lowers inflation.

The relationship between

inflation and unemployment

is actually more complicated than that.

But first let's look at why we may think

that they move in opposite directions.

Start with our aggregate supply

aggregate demand model.

We have an upward sloping

short-run aggregate supply curve

due to the misperceptions theory.

Suppose the economy

is currently at potential output

which results in full employment.

If the central bank

conducts expansionary monetary policy

that will shift out aggregate demand.

If that shift is anticipated by producers

they will simply mark up their prices

by an equivalent amount

and keep producing the same quantity.

That shows up as a simultaneous upward shift

in the short-run aggregate supply.

The result is higher prices

but no change in output.

However, if businesses don't anticipate

the shift in aggregate demand

we'll instead see a move along

on the short-run aggregate supply.

Firms will interpret rising prices

as an increase in demand

for their specific goods

and will produce more.

Prices will rise, output will rise,

and unemployment will fall.

So inflation and unemployment

are moving in opposite directions here.

Likewise, unanticipated contractionary policy

would cause aggregate demand to shift in

with a move along on SRAS.

Output would fall, unemployment would rise,

an inflation would fall.

So that's why economists claim

that there is a negative relationship

between inflation and unemployment.

That relationship shows up on a graph

of those two variables like this.

This line is called the Phillips Curve

after the economists

who proposed this theory.

However, when we look at actual data

from the economy

for inflation and unemployment,

there's no clear relationship.

What's going on?

Back to aggregate supply aggregate demand.

When the boost aggregate demand

was unanticipated

we moved along short-run aggregate supply

raising prices and lowering unemployment,

but producers won't be fooled forever.

Eventually they'll see their costs rising,

and realize that higher prices

were general inflation

not more demand for their product.

They'll adjust their product prices

to reflect their higher cost.

This shows up as the shift up

for short-run aggregate supply.

Prices climb higher still

but output goes back to potential.

Unemployment rises back to its normal level.

Back in our Phillips Curve graph

when producers adjust their expectations

about inflation,

that shows up

as a shift in the Phillips Curve.

When producers realize

that inflation is higher than they expected

and raise their prices while cutting output,

that shows up as a upward shift

in the Phillips Curve.

That's bad news for monetary policymakers.

Their goal is stable prices

and low unemployment

and this shift makes

both of those problems worse.

They can still lower unemployment

by raising inflation and vice versa

but that trade-off is happening at a place

that has more of both.

On the other hand

when producers revise

their inflation expectations downward

that shifts the Phillips Curve down.

Once again policymakers can still trade-off

between inflation and unemployment

but they're in a place

that has less of both.

That's why

responsible monetary policymakers work hard

to keep inflation expectations very low.

It makes their job of trading off inflation

and unemployment easier

and it's this shifting Phillips Curve

that gives us our mess of historical points.

And many economists argue

that because of these shifts

in the long-run the Phillips Curve

is actually vertical.

Unemployment always eventually returns

to the natural rate

while prices can rise or fall.