8217; will become sharper in each successive period. In other words, to maintain the unemployment below the ‘natural’ rate, policy authorities will have to inflate the economy at higher rates in each successive period. This has a major policy implication even if the economy does not operate on the long-run vertical Phillips curve. “Under the rational expectations hypothesis, as there are no deviations between actual, and expected inflation, both in the short-run and long-run, Phillips curves are treated as being vertical with no trade-off between inflation and unemployment.” Another policy related question is the shape of the short-run Phillips curve itself. In reality, wages and prices are sticky as employment contracts are fairly long and there is also a cost in changing the individual prices too often, or re-negotiating wages after each price rise. It has been argued that the nature of stickiness in wages and prices could be different in different economies, and this could also be a function of the inflation history of the country concerned. If so, countries with high inflation rates would find themselves steeper on short-run Phillips curve than low inflation countries, which are more likely to be on the flatter side. For the purpose of this paper, what is important, therefore, is that the trade-off between price stability and employment is sharper for countries with relatively high inflation rates, and lower for those with low inflation rates. Price Stability as the objective of Monetary PolicyPrice stability as the objective of monetary policy rests on the notion that volatility in prices creates uncertainty in decision making. Rising prices affect savings adversely while making speculative investments more attractive. Thus, the most important contribution of the financial system to an economy is its ability to increase savings and allocate resources more efficiently. A regime of rising prices dampe...
