Created 4/12/1998
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The Monetary Policy Reaction Function

J. Bradford DeLong

The Phillips curve--the downward-sloping inverse relationship between unemployment and inflation--tells us the tradeoff between unemployment and inflation at any one moment in time, for the current values of expected inflation and the natural rate of unemployment.

Where on the current Phillips curve is the economy? Add to the graph an aggregate demand relation based on a monetary policy reaction function: When inflation is higher than expected (or desired), central banks get nervous and take steps to cool the economy off, raising unemployment. Expansionary policy moves the monetary policy reaction function to the right; contractionary policy to the left.

The point where the monetary policy reaction function crosses the Phillips curve is the current level of inflation and unemployment.

The Monetary Policy Reaction Function    Easing Policy--Adaptive Expectations    Easing Policy--Rational Expectations  

Professor of Economics J. Bradford DeLong, 601 Evans Hall, #3880
University of California at Berkeley
Berkeley, CA 94720-3880
(510) 643-4027 phone (510) 642-6615 fax

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