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Why are the benefits of reducing inflation permanent and the costs temporary? Why are the costs of increasing inflation permanent and the benefits temporary? Use Phillips-curve diagrams in your answer.
Principles of Macroeconomics (Mind...
Solutions
Principles of Macroeconomics (Mind...
Why are the benefits of reducing inflation permanent and the costs temporary? Why are the costs of increasing inflation permanent and the benefits temporary? Use Phillips-curve diagrams in your answer.
Explanation of Solution
The benefits of reducing inflation are permanent, whereas the costs of reducing inflation are temporary. On the other hand, the benefits of increasing inflation are temporary and the costs of increasing inflation are permanent. These arguments can be reasoned out using Figure 1. Figure 1 illustrates the Phillips curve that shows the trade-off between the inflation rate and unemployment rate. The horizontal axis of Figure 1 represents the unemployment rate and the vertical axis represents the inflation rate.
Case 1: Reduction of Inflation
Assume that the economy begins at point A. For reducing inflation, the Central bank would adopt a contractionary policy and as a result, the economy would move down the short-run Phillips curve SRPC1. This leads to a decline in inflation but with a rise in unemployment...
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