ECO 304L Study Guide - Midterm Guide: Phillips Curve, Monetary Policy, Shortage
20 Oct 2017
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Monetary policy makers around the world took an important lesson from this experience. Do not let inflation expectations get too high, otherwise you might have to endure a nasty recession to get them back to an acceptable level. This is part of the reason that central banks seem to be so worried about inflation. They do not want to have to cause unemployment if inflation heats up and drags expectations higher. As the discussion above shows, this lesson applies to supply shocks. But it also could apply to high demand. If demand pushes above y*, even temporarily, inflation can rise. Reducing demand back to y* would reduce the inflationary pressure. But if inflation expectations increase, the effect on inflation can be persistent even if the excess demand is temporary. The only way to bring inflation expectations down may be to create a recession. (see the next topic for further discussion. )
