The expectations-augmented Phillips Curve

The economist Milton Friedman argued that in the long run, there was no trade-off
between unemployment and inflation
.

He argued that unemployment was not traded with actual inflation but expected inflation.
Therefore the Philips Curve was a short run phenomena changes in levels of
unemployment were affected by expectations of rates of inflation.

So increasing aggregate demand by monetary expansion increases the expectation that
inflation will go up. This shifts the Phillips curve to the right. i.e. unemployment increases
because firms expect inflation.

Freidman was a monetarist. The monetarist view is that attempts to boost AD artificially
to achieve faster growth and lower unemployment have only a
temporary effect on
unemployment.

Friedman argued that a government could not permanently drive unemployment down
below the NAIRU if unemployment is forced below
NAIRU higher inflation occurs
leading to higher unemployment higher inflationary expectations.
















This is illustrated in the next diagram inflation expectations are higher for SPRC2. The
result may be that higher unemployment is required to keep inflation at a certain target
level.

The expectations-augmented Phillips Curve in trying to reduce unemployment below the
natural rate of unemployment by boosting AD has little success in the long run. What
happens instead is to create higher inflation with increased inflationary expectations.
Monetarists believe inflation is best controlled through tight control of money and credit.
Credible policies to keep on top of inflation can also have the beneficial effect of reducing
inflation expectations causing a downward shift in the Phillips Curve.

Long run Phillips Curve

This is drawn as a vertical line i.e. the long run Phillips curve is no more than NAIRU (non
accelerating inflation rate of unemployment)


















Reducing the long run Phillips Curve (or NAIRU), i.e. shifting the LRPC to the left, can be
brought about by supply-side policies example labour market reforms might be
successful in reducing frictional and structural unemployment perhaps because of
improved incentives to find work or gains in the human capital of the workforce that
improves the occupational mobility of labour.