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Cunningham
Original Phillips Curve
A. W. Phillips (1958), “The Relation
Between Unemployment and the Rate of
Change of Money Wage Rates in the
United Kingdom, 1861-1957”, Economica.
Wage inflation vs. Unemployment
New Zealander at London School of
Economics
Missing Equation of Keynesian
economics?
2
5½ % = zero inflation
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5½ %
4
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 5½%.
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Conclusions, Continued
From the dispersion of the dw
data points, Phillips w
concluded that there was a
countercyclical “loop”:
– Money wages rise faster
as du/dt decreases, faster
– Money wages fall slower
as du/dt increases
– Implies an inflationary slower
bias, and is consistent
with sticky wage theory. u
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Problems with Phillips’ Study
Empirical method suspect.
Is this an empirical result in search of a theory?
To tie to theory, need a way to relate this to real
wages in order to connect this to labor market
conditions.
R.G. Lipsey (1960) attempts to address these
points in “The Relationship Between
Unemployment and the Rate of Change of Money
Wage Rates in the UK, 1862-1957: A Further
Analysis”.
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Lipsey’s Phillips Curve
Derives the Phillips curve from supply-demand analysis of the labor
market.
Ns = N + U
Nd = N + V
Where U refers to the number unemployed,
V refers to the number of job vacancies.
Excess demand Nd – Ns = X = V – U.
So
X V U
s
s s x v u
N N N
Where v is the vacancy rate and u is the unemployment rate.
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Lipsey, Continued
Step One. Wage Adjustment Function
dw N d N s
w k s
dN N
This amounts to saying that the change in the money wage rate
is proportional to the excess demand for labor.
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Lipsey, Continued
Individual Labor Market Conditions
wage inflation
d s
N N Asymptotic dw
x
Ns (u=0 not possible) w
uf u unemployment
dw
w
uf u
Individual
labor market
d s
N N
x 10
Ns
Lipsey, Continued
The result is a Phillips curve for an
individual market.
Next, aggregate across markets for
the aggregate Phillips curve.
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Samuelson-Solow (1960)
P. Samuelson and R. Solow. “The Problem of Achieving and Maintaining a
Stable Price Level: Analytical Aspects of Anti-Inflation Policy,” American
Economic Review (May 1960), 177-94.
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Samuelson-Solow, Continued
Pt y t (1 a )Wt Nt
nominal nominal
output (GDP) wage bill
yt
Let t (labor productivity)
Nt
Substituting: Wt
Pt (1 a )
t
In logs:
log Pt log(1 a ) logWt log t
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Samuelson-Solow, Continued
This implies:
Pt Wt t
Pt Wt t
or w
inflation rate = wage inflation rate
– growth rate of labor productivity
Increases in wages matched by productivity
increases are not inflationary.
There is a relationship between wage inflation
and goods price level inflation.
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Samuelson-Solow, Continued
Generalize further in the form of a Phillips curve relation:
e 1
w bu , b 0, 0 1
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Samuelson-Solow, Continued
e bu 1 (1 )
This is the modern Phillips curve.
Technical relation between inflation
and unemployment.
Each point is an equilibrium state of
the economy.
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Friedman-Phelps Phillips Curve
Milton Friedman. “The Role of Monetary Policy,” American Economic
Review (March 1968), 1-17.
Edmund Phillips. “Phillips Curves, Expectations of Inflation and Optimal
Employment Over Time,” Economica (August 1967), 254-81)
Short run
Phillips curves
e=1
U
U1 U* e=0
Accelerationist Hypothesis:
let f (u ) b(ut u *)
Use adaptive expectations:
et t 1 (1 ) et1
So that
t t 1 (1 ) et1 b(ut u *)
Problem: et1 is not observable.
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Friedman’s
Accelerationist Hypothesis
Lag one period, multiply by (1 )
(1 )t 1 (1 ) et1 b(1 )(ut 1 u *)
Subtract from the original equation:
t t 1 b(1 )(ut 1 u *) b(ut 1 u *)
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Friedman’s
Accelerationist Hypothesis
Substituting,
t t 1 b(ut u *) b(1 )(ut ut 1 )
But t t 1 t t 1 0
and ut ut 1 ut ut 1 0.
So 0 b(ut u *)
and ut u * .
AD2
AD1
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More Friedman
In his Nobel lecture, Friedman offered the
possibility of a positively-sloped Phillips curve:
– “Stabilization” policy increases the inflation rate and
variability.
– This requires nominal contracts to be renegotiated to
shorter lengths.
– Efficiency is lowered.
– Inventories grow.
– Unemployment rises.
“The broadcast about relative prices is, at it were,
being jammed by the noise coming from the
inflation broadcast.”
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