3/1/2010

UNEMPLOYMENT

AND INFLATION

THE PHILLIPS CURVE

1958

Relationship between Unemployment and Inflation

Professor A.W. Phillips a statistical relationship between the rate of growth of money wages and unemployment from 1861 1957 Rate of growth of money wages linked to inflationary pressure Led to a theory expressing a trade-off between inflation and unemployment
Expressed

Sloman (7th Edition) p 436

5 % = zero inflation

The Phillips curve and the U.S. economy during the 1960s

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THE ORIGINAL PHILLIPS CURVE

9 8 7

Wage inflation (%)

6 5 4 3 2 1 0 0 1 2 3 4 5 6

5 %

Unemployment (%)

Phillips Conclusions:
There exists a stable relationship between the
variables. The relationship has not substantially changed for over 100 years. Negative, nonlinear correlation. Wages remain stable/stationary dw ( w =0) when unemployment is 5%.

THE PHILLIPS CURVE

Wage growth % (Inflation)

2.5%

The Phillips Curve shows an inverse relationship between inflation and unemployment. It suggested that if governments wanted to reduce unemployment it had to accept higher inflation as a trade-off. Money illusion wage rates rising but individuals not factoring in inflation on real wage rates.

1.5%

4%

6%

PC1

Unemployment (%)

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3/1/2010

THE PHILLIPS CURVE

Wage growth % (Inflation)

The Phillips Curve

An inward shift of the Phillips Curve would result in lower unemployment levels associated with higher inflation.

3.0%

1.5%

Problems: 1970s Inflation and unemployment rising at the same time stagflation Phillips Curve redundant? Or was it moving?

4%

6% PC2

PC1

Unemployment (%)

Inflation and unemployment in the United States, 19702002

BREAKDOWN OF THE PHILLIPS CURVE

1966 the Phillips curve relationship seemed to break down UK and many other countries started to experience growing unemployment as well as higher rates of inflation Why?

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Inflation (%)
26 24 22 20 18 16 14 12 10 8 6 4 2 0 0 1 2 3 4 5 6 7 65 66 62 61 64 67 63 60

The breakdown of the Phillips curve?

Inflation (%)
26 24 22 20 18 16 14 12 10 8 6 4 61 2 0 65 66 62 64 67 63 60 2 3 4

The breakdown of the Phillips curve?

Original Phillips curve

10

11

12

13

10

11

12

13

Unemployment (%)

Unemployment (%)

Inflation (%)
26 24 22 20 18 16 14 12 10 8 6 4 2 0 0 1 2 3 4 5 6 7 70 69 65 68 62 66 61 64 67 63 60 73 71 72 74

The breakdown of the Phillips curve?

Inflation (%)
26 24 22 20 18 16 14 12 10 8 6 4 2 0 70 69 65 68 62 66 61 64 67 63 60 0 1 2 3 4 5 6 7 73 71 72 78 74 79 76 77 75

The breakdown of the Phillips curve?

10

11

12

13

10

11

12

13

Unemployment (%)

Unemployment (%)

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Inflation (%)
26 24 22 20 18 16 14 12 10 8 6 4 2 0 0 1 2 3 4 5 6 7 70 69 65 68 62 66 61 64 67 63 60 73 71 72 78 74 79 76 77 80 75

The breakdown of the Phillips curve?

THE PHILLIPS CURVE

Inflation Long Run PC

81

3.0%

82 2.0% 85 84 83 1.0%

To counter the rise in unemployment, government once again injects resources into the economy the result is a short-term fall in unemployment but higher inflation. This higher Assumefuels the economy starts with an inflation inflation further expectation of rate of 1% but very high unemployment at 7%. higher inflation and so the process Government takes measures to reduce continues. The long run Phillips Curve unemployment by an expansionary fiscal policy that pushes to natural the right (see the AD/AS is vertical atAD the rate of diagram on slide 15) unemployment. This is how economists have explained the movements in the Phillips Curve and it is termed the Expectations Augmented Phillips Curve.

PC1 7% 8 9 10 11 12 13 PC3 PC2 Unemployment

Unemployment (%)

THE PHILLIPS CURVE

THE PHILLIPS CURVE

Where the long run Phillips Curve cuts the horizontal axis would be the rate of unemployment at which inflation was constant the so-called Non-Accelerating Inflation Rate of Unemployment (NAIRU)

To reduce unemployment to below the natural rate would necessitate:

1. 2.

Influencing expectations persuading individuals that inflation was going to fall Boosting the supply side of the economy - increase capacity (pushing the PC curve outwards)

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Inflation (%)

The breakdown of the Phillips curve?

75

RELATIONSHIP BETWEEN INFLATION AND UNEMPLOYMENT The 'Phillips curve' in recent times

26 24 22 20 18 16 14 74 79 81 73 70 69 65 68 62 66 61 64 67 63 60 0 1 2 3 4 5 6 7 8 71 72 78 90 89 91 88 95 94 92 82 85 87 93 86 76 77 80

the breakdown of the Phillips curve and the problem of stagflation in the 1970s experience of the 1980s experience of recent years

12 10 8 6 4 2 0 9

84

83

10

11

12

13

Unemployment (%)

Inflation (%)

The breakdown of the Phillips curve?

75

RELATIONSHIP BETWEEN INFLATION AND UNEMPLOYMENT The 'Phillips curve' in recent times

26 24 22 20 18 16 14

the breakdown of the Phillips curve and the problem of stagflation in the 1970s experience of the 1980s experience of recent years a horizontal Phillips curve?

76 74 79 77

80

12 10 8 6 4 2 0 0 1 2 3 4

81 73 70 69 65 68 62 66 61 64 67 63 60 71 72 78 90 89 91 88 97 96 95 94 92 82 85 87 93 86

84

98 06 05 03 02 04 01 00
5 6

83

99

10

11

12

13

Unemployment (%)

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RELATIONSHIP BETWEEN INFLATION AND UNEMPLOYMENT The 'Phillips curve' in recent times

the breakdown of the Phillips curve and the problem of stagflation in the 1970s experience of the 1980s experience of recent years a horizontal Phillips curve?

Complexity

of the relationship between inflation and unemployment

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