The Philips Curve
The Philips curve shows the relation between inflation and the Unemployment rate saying as unemployment is low inflation is high,conversely as unemployment is high inflation is low. Two of the main macroeconomic objectives low inflation and unemployment had been said to be mutually exclusive- meaning a TRADE OFF.
However it has been said that there was a break down of the Philips curve in the 1970s because there was a period of stagflation where there were both high levels of inflation and unemployment.
Monetarist economists, like the American Milton Friedman had said that the short run Philips curve was applicable but in the long run there was no such trade off because unemployment would always be at Natural Rate of Unemployment. This had said to be impossible to reduce unless there was ever accelerating unanticipated inflation.
The Original Philips Curve had said that it wrongly took in account of the current rate of inflation but not the expected rate. So this is where the Expectations Augmented Philips Curve comes in as it does this.
This is as people would normally tend to form expectations of future inflation on the basis of the current rate of inflation. So it starts with 0 the future will tend to be 0% however if the government tries to stimulate aggregate demand it be a different case. Lets AD increases leading to a 5% inflation. In the short run the original Philips curve does show a trade off as unemployment shifts from A to B from the diagram above shown. However it is not sustainable as for workers to supply more labour the real wage must rise however in the short run they are suffering from money illusion. However in the long run they realise this and get off money illusion and realise their wage is not rising as fast its cost. So they decide not to supply their labour unless their wage actually increases in real terms. So therefore move to point C where there is a new short run philips curve and it is still on the long run philips curve but at a higher inflation.
In order to tackle natural rate of unemployment supply side reforms are needed