This chapter discusses the temporary tradeoff between inflation and unemployment that arises from unanticipated inflation. A rising rate of inflation may reduce unemployment, and the effects may last for something like two to five years. The negative relationship between inflation and unemployment is shown on the Philips curve. To get to a point on the Philips curve with higher inflation and lower unemployment, policymakers expand aggregate demand. The opposite is true for a point on the Philips curve with lower inflation and higher unemployment (contracting aggregate demand).
The relationship between inflation and unemployment holds true only in the short run because in the long run, expected inflation adjusts to changes in actual inflation; thus shifting the short-run Philips curve. In the long run, this curve is vertical at the natural rate of unemployment.
Adverse supply shock->policymakers must accept a higher rate of inflation for any given rate of unemployment or a higher rate of unemployment for any given rate of inflation.
