An article in the Economist started by stating that “central banks cannot endlessly reduce unemployment without sparking inflation is economic gospel. It follows from ‘a substantial body of theory, informed by considerable historical evidence,’ according to Janet Yellen, chair of the Federal Reserve.”
a. Use a graph of the Phillips curve to show that central banks cannot endlessly reduce unemployment without sparking inflation. Briefly explain how your graph illustrates this point. Give an example of historical evidence that Fed Chair Yellen could be referring to.
b. The article stated that the “effects of unemployment on inflation can get lost amid temporary economic gyrations. That is most obvious when oil prices fall, as they did in late 2014.” What does the article mean by the “effects of unemployment on inflation can get lost amid temporary economic gyrations?” Use a graph of the Phillips curve to show the effect on inflation of a fall in oil prices. Briefly explain what is happening in your graph.
c. In discussing the effect of inflationary expectations, the article stated that “self-fulfilling expectations could explain low inflation.” Use a graph of the Phillips curve to show how self-fulfilling expectations could explain low inflation. Briefly explain what is happening in your graph.