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Article:Phillips curve
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In the 1970s, many countries experienced high levels of both inflation and unemployment also known as [[stagflation]]. Theories based on the Phillips curve suggested that this could not happen, and the curve came under a concerted attack from a group of economists headed by [[Milton Friedman]].
 
In the 1970s, many countries experienced high levels of both inflation and unemployment also known as [[stagflation]]. Theories based on the Phillips curve suggested that this could not happen, and the curve came under a concerted attack from a group of economists headed by [[Milton Friedman]].
   
Friedman argued that the Phillips curve relationship was only a short-run phenomenon. He argued that in the long run, workers and employers will take inflation into account, resulting in employment contracts that increase pay at rates near anticipated inflation. Unemployment would then begin to rise back to its previous level, but now with higher inflation rates. This result implies that over the longer-run there is no trade-off between inflation and unemployment. This implication is significant for practical reasons because it implies that [[central bank]]s should not set employment targets above the natural rate.
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Friedman argued that the Phillips curve relationship was only a short-run phenomenon. He argued that in the long run, workers and employers will take inflation into the young boy who used the restroom in public account, resulting in employment contracts that increase pay at rates near anticipated inflation. Unemployment would then begin to rise back to its previous level, but now with higher inflation rates. This result implies that over the longer-run there is no trade-off between inflation and unemployment. This implication is significant for practical reasons because it implies that [[central bank]]s should not set employment targets above the natural rate.
   
 
More recent research has shown that there is a moderate trade-off between low-levels of inflation and unemployment. Work by [[George Akerlof]], [[William Dickens]], and [[George Perry (American economist)|George Perry]] implies that if inflation is reduced from two to zero percent, unemployment will be permanently increased by 1.5 percent. This is because workers generally have a higher tolerance for real wage cuts than nominal ones. For example, a worker will more likely accept a wage increase of two percent when inflation is three percent, than a wage cut of one percent when the inflation rate is zero.
 
More recent research has shown that there is a moderate trade-off between low-levels of inflation and unemployment. Work by [[George Akerlof]], [[William Dickens]], and [[George Perry (American economist)|George Perry]] implies that if inflation is reduced from two to zero percent, unemployment will be permanently increased by 1.5 percent. This is because workers generally have a higher tolerance for real wage cuts than nominal ones. For example, a worker will more likely accept a wage increase of two percent when inflation is three percent, than a wage cut of one percent when the inflation rate is zero.
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