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Chapter 16Econ 104 Parks

The Phillips Curve The Phillips Curve

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The Phillips Curve

•The Phillips curve is a graph illustrating the inverse relationship between inflation and the unemployment rate.

•The Phillips curve is a graph illustrating the inverse relationship between inflation and the unemployment rate.


The Early Consensus

• Economists in the late 1950s and 1960s thought that all the Federal Reserve or government had to do was to pick the point on the short-run Phillips curve where they wanted the economy to be positioned.

• Less unemployment meant living with more inflation, and vice versa.

• Economists in the late 1950s and 1960s thought that all the Federal Reserve or government had to do was to pick the point on the short-run Phillips curve where they wanted the economy to be positioned.

• Less unemployment meant living with more inflation, and vice versa.


Breakdown of the Short-Run Phillips Curve

• In the 1970s and early 1980s the short-run relationship between inflation and unemployment seemed to break down.

• In the 1970s and early 1980s the short-run relationship between inflation and unemployment seemed to break down.

Phillips Curve, 1966 to 1988

1987 1983

1978

1974

197219661968

19691973

1970

1975

1976

1979

1980

1981

1982

1984

1986

0

2

4

6

8

10

12

14

16

0 2 4 6 8 10 12

Unemployment (%)

Infl

ati

on

(%

)


Breakdown of the Short-Run Phillips Curve

• A spiral pattern emerged in the Phillips curve.

• Economists were able to salvage the Phillips curve by realizing that a significant difference exists between the short-run and long-run relationships between inflation and unemployment.

• A spiral pattern emerged in the Phillips curve.

• Economists were able to salvage the Phillips curve by realizing that a significant difference exists between the short-run and long-run relationships between inflation and unemployment.


The Long-Run Phillips Curve

• Most economists now agree that in the long run there is no tradeoff between inflation and unemployment.

• Most economists now agree that in the long run there is no tradeoff between inflation and unemployment.


The Long-Run Phillips Curve

• The long-run Phillips curve is simply a vertical line at the natural rate of unemployment, U*.

• Any level of inflation is consistent with the natural rate of unemployment.

• The long-run Phillips curve is simply a vertical line at the natural rate of unemployment, U*.

• Any level of inflation is consistent with the natural rate of unemployment.


Aggregate Demand Shifts and the Phillips Curve

• We can "explain" both the short-run and long-run Phillips curves by using the Aggregate Demand/Aggregate Supply model that we developed in Chapter 8.

• We can "explain" both the short-run and long-run Phillips curves by using the Aggregate Demand/Aggregate Supply model that we developed in Chapter 8.


Expansionary Policy, AD/AS, and the Phillips Curve


Contractionary Policy, AD/AS, and the Phillips Curve


The Role of Expectations

• The short-run tradeoff between inflation and unemployment is thought to work because people have an idea of what inflation expectations are going to be, and those expectations change slowly.

• Over time, workers learn that inflation has changed and they change their inflation expectations accordingly.

• The short-run tradeoff between inflation and unemployment is thought to work because people have an idea of what inflation expectations are going to be, and those expectations change slowly.

• Over time, workers learn that inflation has changed and they change their inflation expectations accordingly.



• We can express the Phillips curve as an equation in the following manner:

P = b(U* - U) + Pe

where b > 0,

P is the inflation rate, and

Pe is the expected rate of inflation.

• We can express the Phillips curve as an equation in the following manner:

P = b(U* - U) + Pe

where b > 0,

P is the inflation rate, and

Pe is the expected rate of inflation.



• The long-run Phillips curve equation suggests that the inflation rate is entirely determined by inflation expectations. When inflation expectations rise, the Phillips curve shifts upward.

• The long-run Phillips curve equation suggests that the inflation rate is entirely determined by inflation expectations. When inflation expectations rise, the Phillips curve shifts upward.


Shifts in the AS Curve and the Phillips Curve

• When the Aggregate Supply curve shifts, we can get very different results in the Phillips curve than when the Aggregate Demand curve shifts.

• An oil shock, for example, can produce stagflation.

• When the Aggregate Supply curve shifts, we can get very different results in the Phillips curve than when the Aggregate Demand curve shifts.

• An oil shock, for example, can produce stagflation.



• Policy makers are left with difficult decisions once the economy moves to point B.

• Policy makers are left with difficult decisions once the economy moves to point B.



• Supply shifts affect both long run and short run• Supply shifts affect both long run and short run

LRAS’LRPC’



• Another possibility• Another possibility

LRAS’ LRPC’



Long Run

• Point B may not be long run equilibrium. With unemployment, workers adjust their wage demands downward, shifting AS to the right to achieve equilibrium. But accepting lower wages shifts AD inward.

• As an external shock, oil prices, shifted short run AS, it will also shift long run AS. The equilibrium is less GDP and higher price levels.

• Point B may not be long run equilibrium. With unemployment, workers adjust their wage demands downward, shifting AS to the right to achieve equilibrium. But accepting lower wages shifts AD inward.

• As an external shock, oil prices, shifted short run AS, it will also shift long run AS. The equilibrium is less GDP and higher price levels.

Is the Phillips Curve Dead?

•Despite being reconstructed in the 1970s, the Phillips curve relationship was suspiciously absent again in the mid- to late-1990s.

•Despite being reconstructed in the 1970s, the Phillips curve relationship was suspiciously absent again in the mid- to late-1990s.

Phillips Curve, 1994 to 2005

0

1

2

3

4

2 3 4 5 6 7 8Unemployment (%)

Infl

ati

on

(%))

1994

19951996

2000

1999

1998

2003

2002

1997

2001

2005

2004



Phillips 1948-2009

-0.04

-0.02

0

0.02

0.04

0.06

0.08

0.1

0.12

0.14

0.16

0.0 2.0 4.0 6.0 8.0 10.0 12.0


Phillips 1992-2000

0

0.005

0.01

0.015

0.02

0.025

0.03

0.035

0.04

0.0 1.0 2.0 3.0 4.0 5.0 6.0 7.0 8.0 9.0


Phillips 2001-2009

-0.01

0

0.01

0.02

0.03

0.04

0.05

0.06

0.0 1.0 2.0 3.0 4.0 5.0 6.0 7.0 8.0 9.0


Phillips 1992-2000

0

0.005

0.01

0.015

0.02

0.025

0.03

0.035

0.04

0.0 1.0 2.0 3.0 4.0 5.0 6.0 7.0 8.0 9.0


Phillips 1992-2000, inflation without energy & food

0

0.005

0.01

0.015

0.02

0.025

0.03

0.035

0.04

0.045

0.0 1.0 2.0 3.0 4.0 5.0 6.0 7.0 8.0 9.0


Phillips 1992-2000

0

0.005

0.01

0.015

0.02

0.025

0.03

0.035

0.04

0.0 1.0 2.0 3.0 4.0 5.0 6.0 7.0 8.0 9.0

Phillips 1992-2000, inflation without energy & food

0

0.005

0.01

0.015

0.02

0.025

0.03

0.035

0.04

0.045

0.0 1.0 2.0 3.0 4.0 5.0 6.0 7.0 8.0 9.0


Phillips 2001-2009

-0.01

0

0.01

0.02

0.03

0.04

0.05

0.06

0.0 1.0 2.0 3.0 4.0 5.0 6.0 7.0 8.0 9.0

Phillips 2001-2009, inflation without food & energy

0

0.005

0.01

0.015

0.02

0.025

0.03

0.035

0.0 1.0 2.0 3.0 4.0 5.0 6.0 7.0 8.0 9.0

Is the Phillips Curve Dead?

• Two viewpoints on the relevance of the Phillips Curve:– The relationship between inflation and unemployment has

disappeared altogether.

– Special circumstances such as an increase in labor productivity account for the lack of a relationship. The relationship will return once these factors subside.

• One consensus that certainly has emerged is that the Phillips curve is not a reliable tool to forecast inflation or unemployment.

• Two viewpoints on the relevance of the Phillips Curve:– The relationship between inflation and unemployment has

disappeared altogether.

– Special circumstances such as an increase in labor productivity account for the lack of a relationship. The relationship will return once these factors subside.

• One consensus that certainly has emerged is that the Phillips curve is not a reliable tool to forecast inflation or unemployment.


chapter 16 econ 104 parks the phillips curve © onlinetexts.com p. ‹#›

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