Expectations, Inflation and Full Employment

Abstract

As so far developed, aggregate demand and aggregate supply curves are of limited interest. They come into their own when ‘augmented’ with price expectations. The vehicle for moving to expectations augmented aggregate supply and demand is the Phillips curve, which summarises the relationship between unemployment and the rate of inflation via the intermediary of money wage changes. First we consider the alleged trade-off between the level of unemployment and the rate of inflation (the ‘Phillips curve’), which allows one to derive the ‘expectations augmented’ versions of aggregate demand and supply. Section 14.2 puts together the aggregate supply and demand curves in their expectations-augmented versions to tell inflation stories, with emphasis on the new classical parables. Section 14.3 retells the stories with a fixed money wage.