Transcript Phillips curve

Chapter 16
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.
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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.
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Breakdown of the Short-Run Phillips
Curve
Phillips Curve, 1966 to 1988
16
14
1980
Inflation (%)
12
1979
1974
10
1981
1975
1978
8
1969
6
1970
1968
1966
4
1982
1973
2
1976
1984
19721987 1986
1983
0
0
2
4
6
8
10
12
Unemployment (%)
• In the 1970s and early 1980s the short-run relationship between
inflation and unemployment seemed to break down.
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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.
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The Long-Run Phillips Curve
• Most economists now agree that in the long run there is no
tradeoff between inflation and unemployment.
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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.
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Aggregate Demand Shifts and the
Phillips Curve
• We can "explain" both the short-run and longrun Phillips curves by using the Aggregate
Demand/Aggregate Supply model that we
developed in Chapter 8.
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Expansionary Policy, AD/AS, and the
Phillips Curve
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Contractionary Policy, AD/AS, and the
Phillips Curve
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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.
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The Role of Expectations
• 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.
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The Role of Expectations
• 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.
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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.
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Shifts in the AS Curve and the Phillips
Curve
• Policy makers are left with difficult decisions once the economy
moves to point B.
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Is the Phillips Curve Dead?
Phillips Curve, 1994 to 2005
4
2005
2000
Inflation(%))
1996
1995
2001
3
1994
2004
1999
2
1997
2003
2002
1998
1
0
2
3
4
5
6
Unemployment (%)
7
8
•Despite being
reconstructed in
the 1970s, the
Phillips curve
relationship was
suspiciously
absent again in
the mid- to late1990s.
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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.
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