Question

7. Historically, there tends to be an inverse relationship between the rate of inflation and the rate of
unemployment (often illustrated by the Phillips Curve), with few exceptions.
b. In the 1970s, the US economy displayed two periods of both high inflation (in the double-digits),
and high unemployment, called stagflation. What were the unique events/trends taking place
which led to this unusual phenomenon? Use the model of aggregate supply and aggregate
demand to help explain your answer.
c. In the 1990s, the US economy experienced the opposite, as both inflation and unemployment
rates were at historic lows. What were the key events/trends which led to this unusual
outcome? Use the model of aggregate supply and aggregate demand to help explain your
answer.
d. In the current [sluggish] recovery, do we see the typical relationship hold? Why or why not?
What kinds of policies might help? What might be some of the unintended consequences?

refer the book MACROECONOMICS by author N Gregory Mankiw edition 10 and answer in detail

Answer 1

Answer b :-

REASONS :-

There were two main reasons for US stagflation in 1970 .

1) The economy faced a supply shock due to rapid increase of price of oil . This led to increase in price and slowed the economic growth.

2) Government policies to correct unemployment though increasing money supply in the economy led to inflation.

In the above graph we can see that a more expansionary policy led to decrease in interest rates from r1 to r2

AD2 D AS S2 Roal Inlret Rale ADI AD AS AD) 19ahat

Lower interest rates increased the aggregate demand from AD1 to AD2.

With increase in demand , real output rose , thereby rising the prices to P2

Answer c :-

REASONS :-

Two main reasons for economic recession of 1990 were :-

1) Restrictive monetary policy enacted by federal reserve .

2) Passing if tax reform act of 1986 leading to end of real estate boom .

ADJ AS AD2 SI Reas Inkest Rake Lavel ADI Sa AD 2 S I AS furds Y YI O Vyf leanable

A shift to a more restrictive monetary policy led to increase in real interest rates .

Higher interest rates led to decrease in aggregate demand to AD2 .

With this change in demand real output declined to Y2 and decreased the price to P2.

Answer d :-

RELATIONSHIP :-

Phillips curve helps to understand the relationship between unemployment and wage inflation.

When demand for labour is high and there are few unemployed workers , employers can be expected to bid wages up rapidly.

However when the demand for labour is low and unemployment is high , workers are reluctant to accept lower wages than the prevailing rate as a result wages fall very slowly.

POLICIES :-

Following are some of the policies that will facilitate economic recovery :-

1) Government should implement policies to increase aggregate demand .

2) Monetary policies facilitating readjustment of prices and wages .

3) Expansionary fiscal policy to increase spending by reducing taxes .

CONSEQUENCES :-

Following will be some of the consequences of economic recovery :-

1) GDP growth

2) Stock market gains

3) Declining unemployment

4) Increased Consumer Confidence.