In the long run no tradeoffs are possible because adaptations are made and the aggregate supply curve shifts. Unexpected inflation can decrease unemployment in three ways. If workers have constant reservation wages and constant expectations about inflation, an unexpected increase in inflation raises nominal wages without raising real wages. Workers do not realize that inflation has increased, so they accept smaller real wages and unemployment decreases. When aggregate demand is greater than expected, inventories fall and prices on remaining goods in stock are higher.
Businesses hire new workers to increase production to offset the falling inventories.
If wage contracts exist, employers must adjust employment to changing conditions. If revenues fall, employers must reduce costs, either by lowering wages or by getting rid of workers. If a wage contract precludes lowering wages, a decrease in inflation will result in unemployment. Adaptive expectations are expectations based on past experience. People expect things to be as they were before, and they take nothing else into account.