on and expected inflation deviating from actual inflation. Based on this knowledge, and its subsequent critiques, the prevailing inflation/monetary policy controversy centres on the possible short-run and long run trade-off between inflation and unemployment. This distinction primarily stems from the “assumption of ‘error-learning’ process in the determination of inflationary expectations - workers do have an anticipation on the inflation, but because they judge the inflation performance from the past data, the adjustment between the expected and actual inflation is slow.” This implies that in the short-run, nominal wage rise will not fully absorb the actual inflation, and as such, there is scope for reducing unemployment through inflation. “As people adjust their expectations of inflation, the short-run Phillips curve shifts upward and unemployment rate returns towards its ‘natural’ level. As the expected inflation catches up with actual inflation, the Phillips curve becomes vertical, denying thereby a ‘trade-off’ between inflation and unemployment in the long run.” Seen in this light, the short term Phillips curve provides a trade-off between inflation and unemployment when an economy is adjusting to shocks in aggregate demand when expected inflation is lower than actual inflation. In the long run, the Phillips curve becomes almost vertical at the (controversial) ‘natural’ rate of unemployment. Though not discussed in this paper, the plausibility of this ‘natural’ rate of unemployment has been cast into doubt in recent years. For the moment, notwithstanding the critique of the ‘natural’ unemployment rate, the Phillips curve presents the possibility of lengthening the short-run ‘trade-offs’ indefinitely, since inflation surprises in each period can elongate the long-run perpetually. But, in that case the ‘trade-offs&#...
