Chapter 17
Inflation, the
Phillips Curve,
and Central
Bank
Commitment
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Chapter 17 Topics
• The Phillips curve, as observed in U.S. data.
• The Friedman-Lucas Money Surprise Model.
• Understanding the behavior of the inflation rate
in the United States.
• Central bank learning
• Central bank commitment
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Figure 17.1 The Phillips Curve
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Friedman-Lucas Money Surprise
Model
• Assume the central bank sets the inflation rate.
• Workers cannot observe all prices and so can
misperceive their real wage.
• The central bank can fool workers into working
harder – if the central bank sets the inflation rate
higher than expected, then real output will be
higher than its trend value.
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Equation 17.1
Friedman-Lucas model can be summarized by:
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Equation 17.2
Rewrite the previous equation:
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Observed Phillips Curve
Correlations
• Phillips curve relations do not exist in all U.S.
data sets.
• We can observe a Phillips curve prior to 1980,
but not after that.
• The Phillips curve shifts over time.
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Figure 17.2 The Phillips
Curve, 1947–1959
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Figure 17.3 The Phillips
Curve, 1960–1969
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Figure 17.4 The Phillips
Curve, 1970–1979
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Figure 17.5 The Phillips Curve,
1980–1989
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Figure 17.6 The Phillips
Curve, 1990–1999
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Figure 17.7 The Phillips
Curve, 2000–2006
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Figure 17.8 The Shifting
Phillips Curve
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Figure 17.9 The Inflation Rate in
the United States, 1947–2006
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Figure 17.10 Deviations From
Trend in Real GDP, 1947–2006
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Explaining U.S. Inflation: Central
Bank Learning
Story:
• Fed observes the Phillips curve relation that holds in
the data in the 1950s, 1960s, and 1970s, and assumes
that it can increase output at the expense of some extra
inflation.
• After experimenting with high inflation and reading
Friedman and Lucas, the Fed learns the error of its
ways.
• In the early 1980s, the Fed commits to reducing
inflation.
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Figure 17.11 The Phillips Curve
relationship in the Friedman-Lucas money
surprise model
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Figure 17.12 The Effects of an
Increase in the Expected Inflation Rate
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Figure 17.13 The Fed’s Preferences
Over Inflation Rates and Output
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Figure 17.14 The Fed Exploits
the Phillips Curve
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Figure 17.15 The Fed Attempts to
Increase Y Permanently
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Explaining U.S. Inflation: Central
Bank Commitment
• The Fed cannot commit to low inflation.
• So long as inflation is low, there is a temptation for the
Fed to create surprise inflation to increase output.
• In equilibrium with rational expectations, people cannot
be fooled, so in equilibrium inflation is at a sufficiently
high level that there is no temptation for the Fed to
increase inflation further.
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Figure 17.16 The Commitment
Problem
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