In the past several chapters we focused on the concepts of the business cycle, macroeconomic stabilization, and classical and Keynesian approaches to business cycle analysis.
Although these concepts are central to today's macroeconomics, actual policy discussions rarely involve such abstract terms. Policy debates tend to focus on highly publicized economic statistics such as inflation and unemployment.
To make a stronger connection between business cycle theories and policy debates, we now take a closer look at unemployment and inflation, first together and then separately.Unemployment and inflation—sometimes referred to as the "twin evils" of macroeconomics—are among the most difficult and politically sensitive economic issues that policymakers face. High rates of unemployment and inflation generate intense public concern because their effects are direct and visible: Almost everyone is affected by rising prices, and few workers can be confident that they will never lose their jobs.
Moreover, there is a long-standing idea in macroeconomics that unemployment and inflation are somehow related. In the first part of this chapter we discuss in some detail the concept of the Phillips curve—an empirical relationship between inflation and unemployment. According to the Phillips curve, inflation tends to be low when unemployment is high and high when unemployment is low. The Phillips curve relationship raises some important questions about how the economy works and how macroeconomic policies should be used.
We then look at unemployment and inflation separately. We examine the costs that each imposes on society and consider the options that policymakers have for dealing with these problems.
This chapter begins Part 4 of the book, the purpose of which is to explore macroeconomic policymaking in detail. Following the discussion of inflation and unemployment in this chapter, in Chapter 13 we address the issue of how economic openness—as reflected in the trading and financial links among countries—affects macroeconomic policy. In Chapter 14 we take a closer look at institutions and debates related to the making of monetary policy and in Chapter 15 we provide a similar overview of fiscal policy.
Learning Objectives
12.1 Describe the Phillips curve relationship between unemployment and inflation.
12.2 Discusswhether the Phillips curve offers a “menu” of inflationunemployment combinationsfrom which policymakers can choose.
12.3 Identify the costs of unemployment and discuss the natural rate of unemployment.
12.4 Discuss the types and costs of inflation.
12.5 Discuss the challenges and costs of reducing inflation.
12.1