14/7/08 10:57 AMPhillips curve - Wikipedia, the free encyclopediaPage 3 of 11http://en.wikipedia.org/w/index.php?title=Phillips_curve&printable=yes
inflation expectations, shifting the short-run curve rightward to the "New Short-Run Phillips Curve" andmoving the point of equilibrium from
. Thus the reduction in unemployment below the "NaturalRate" will be temporary, and lead only to higher inflation in the long run.Since the short-run curve shifts outward due to the attempt to reduce unemployment, the expansionarypolicy ultimately worsens the exploitable tradeoff between unemployment and inflation. That is, it results inmore inflation at each short-run unemployment rate. The name "NAIRU" arises because with actualunemployment below it, inflation accelerates, while with unemployment above it, inflation decelerates.With the actual rate equal to it, inflation is stable, neither accelerating nor decelerating. One practical use of this model was to provide an explanation for Stagflation, which confounded the traditional Phillips curve.The rational expectations theory said that expectations of inflation were equal to what actually happened,with some minor and temporary errors. This in turn suggested that the short-run period was so short that itwas non-existent: any effort to reduce unemployment below the NAIRU, for example, would
cause inflationary expectations to rise and thus imply that the policy would fail. Unemployment wouldnever deviate from the NAIRU except due to random and transitory mistakes in developing expectationsabout future inflation rates. In this perspective, any deviation of the actual unemployment rate from theNAIRU was an illusion.However, in the 1990s in the U.S., it became increasingly clear that the NAIRU did not have a uniqueequilibrium and could change in unpredictable ways. In the late 1990s, the actual unemployment rate fellbelow 4 % of the labor force, much lower than almost all estimates of the NAIRU. But inflation stayedvery moderate rather than accelerating. So, just as the Phillips curve had become a subject of debate, so didthe NAIRU.Further, the concept of rational expectations had become subject to much doubt when it became clear thatthe main assumption of models based on it was that there exists a single (unique) equilibrium in theeconomy that is set ahead of time, determined independent of demand conditions. The experience of the1990s suggests that this assumption cannot be sustained.
The Phillips curve today
Most economists no longer use the Phillips curve in its original form because it was shown to be toosimplistic. This can be seen in a cursory analysis of US inflation and unemployment data 1953-92. There isno single curve that will fit the data, but there are three rough aggregations—1955-71, 1974-84, and 1985-92—each of which shows a general, downwards slope, but at three very different levels with the shiftsoccurring abruptly. The data for 1953-54 and 1972-73 does not group easily and a more formal analysisposits up to five groups/curves over the period.But still today, modified forms of the Phillips Curve that take inflationary expectations into account remaininfluential. The theory goes under several names, with some variation in its details, but all modern versionsdistinguish between short-run and long-run effects on unemployment. The "short-run Phillips curve" is alsocalled the "expectations-augmented Phillips curve", since it shifts up when inflationary expectations rise,Edmund Phelps and Milton Friedman argued. In the long run, this implies that monetary policy cannotaffect unemployment, which adjusts back to its "natural rate", also called the "NAIRU" or "long-runPhillips curve". However, this long-run "neutrality" of monetary policy does allow for short runfluctuations and the ability of the monetary authority to temporarily decrease unemployment by increasinginflation, and vice versa. Blanchard (2000, chapter 8) gives a textbook presentation of the expectations-