The
Original Short Run Phillips Curve
Basic
Assumptions:
·
There is an inverse relationship between inflation and
unemployment. When one increases, the
other decreases.
·
If an economy has inflation, usually due to demand pull growth, then
more workers are being hired to produce the greater number of goods being
produced.
·
If an economy is in a recession, more resources are being left idle,
therefore fewer workers are needed and less pressure is put on the resource
base. This results in less inflation.
·
Movement along the Phillips Curve represents year to year changes in
the business cycle.
The
original data collected in the 1940’s and 1950’s showed this general connection
with the business cycle. This also held during the 1960’s in the US (see most
texts).
Why the Phillips Curve? Notes Page
|
Original SR Phillips Curve
|
|
|
Inflation and Unemployment
=
|
|
|
Inflation =
|
|
|
Recession =
|
|
|
Along the Curve =
|
|
|
Stagflation
|
|
|
Late 1970’s to 1981
|
|
|
Data?
|
|
|
A New Phillips Approach
|
|
|
New Range?
|
|
|
Cost Push Inflation
|
|
|
Supply Shocks
|
|
|
SRPC Curve moves
|
|
|
SRPC moves back
|
|
|
Long Run Phillips Curve
|
|
|
Inflation?
|
|
|
LRPC is?
|
|
|
Natural Rate of
Unemployment
|
|
|
Phillips and AD/AS Curves
|
|
|
Change points on SRPC =
|
|
|
Move the SRPC =
|
|
The
Problem of Stagflation
Phillips
Curves under attack:
·
Starting in the mid-1970’s the economy started to suffer from
increasing amounts of inflation and
unemployment (see the Business Cycles Data chart).
·
The data points on the Phillips Curve no longer fit into any
immediately recognizable pattern.
·
Did the model seem to present the relationship between inflation and
unemployment too simplistically?
A New
“Phillips” Approach
Stagflation,
and its removal, explained:
·
If the fundamental efficiencies and demographics of an economy change,
then the relationship between inflation and unemployment is still valid, just
in a new range.
·
One key change is the type of inflation. If inflation now becomes “cost push”
inflation, the resource base has now changed.
The aggregate supply is reduced due to resources being used up or lost,
disasters, boycotts, etc. More costs and
job losses occur.
·
The result of cost push inflation will be higher prices due to fewer
and more expensive resources, plus more unemployment due to business production
cuts. This is also known as a supply shock.
·
The Short Run Phillips Curve still has a relationship between the two
factors, but the curve moves outward. Year to year business cycles still occur,
just at higher levels than before.
·
When the economy is able to adjust with improved technologies, or the
resource supply is re-established, the inflation pressures level off and
businesses are able to lower costs and produce more. The SRPC moves back inward (to the left).
·
This approach appears to answer the late 1970’s changes. As energy resources were cut and significant
demographic changes like women moving into the workforce changed, the economy
suffered from stagflation. This was
“cured” by the restoration of cheaper energy and new technologies in the 1980’s
and 1990’s.
·
The logic of the Phillips Curve was intact, just in new ranges.
The Long
Run Phillips Curve
Inflation
has less importance in the Long Run.
·
Two new factors emerge in Long Run analysis. The first is that the economy can adjust for
inflation in the long run through wage and real-wage changes. The second is based on Rational Expectations
School theories that expected inflation rates are controllable and predictable
by the market, therefore no longer a random factor.
·
The Long Run Phillips Curve is therefore vertical at some natural rate
of unemployment. This is now presumed to be around 4 to 5 % for the US and 6%
for Canada. This vertical LRPC is also
known as the NAIRU line, or “non accelerating inflation rate of
unemployment”.
·
The analysis of the LRPC is now based on arguments of how a country
can change the natural rate of unemployment.
Usually this is connected to long run productivity of the workforce and the willingness of a country to
help those who are unemployed. The
theory is that financial assistance given to those who lose jobs will lengthen
their “willingness” to wait, or settle, for new jobs. This will increase the natural rate of
unemployment (move it to greater levels of unemployment).
The
Phillips Curve and the AD/AS Model
Phillips
Curves and AD/AS Graphs: Mirror Images
·
When you move points along the SRPC you are showing changes in the
year to year business cycle. This is
exactly what you are illustrating when you move the AD line on the AD/AS model.
·
When you move the entire SRPC outward to show supply shocks or cost
push inflation problems, it is exactly the same at moving the SRAS curve
inward. The AD/AS model will also show the simultaneous creation of greater
inflation and more unemployment. This will also be true of movements in the
opposite directions, like the SRPC moving back inward is the same as the SRAS
curve moving outward to better levels of inflation and production.
Current
Thinking About the Phillips Curve
Recent
and growing critiques of the Phillips Curve use:
·
I quote a brief article from Dr. D. Hamermesh of the University of
Texas at Austin, “By the mid-1980’s the Phillips Curve was no longer taught as
offering a trade-off between inflation and unemployment and was hardly
mentioned in economics courses anymore.”
“…Nobel Prize winners Milton Friedman and Edmund Phelps suggested that
there was no good theoretical basis for the relationship…” These words are typical of university
critiques of the curve.
- Data from the
1990’s forward also seems to show that economies like the US can sustain
long periods of growth, with falling inflation and low, steady levels of
unemployment.
