Transcript Chapter 11: Phillips Curve

Output, Inflation, and Unemployment
Chapter 11
Prof. Steve Cunningham
Intermediate Macroeconomics
ECON 219
Original Phillips Curve
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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?
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5½ % = zero inflation
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5½ %
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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
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From the dispersion of the
data points, Phillips
concluded that there was a
countercyclical “loop”:
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Money wages rise faster
as du/dt decreases,
Money wages fall slower
as du/dt increases
Implies an inflationary
bias, and is consistent
with sticky wage theory.
dw
w
faster
slower
u
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Natural Rate Theory
Milton Friedman
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In the long run, the influence of money is primarily on the
price level and other nominal magnitudes.
In the long run, real variables, such as real output and
employment are determined by real, not monetary, factors.
The equilibrium levels of real output and employment that
are consistent with the microeconomics of production and
the institutions of the society are called the natural rates of
output and employment.
Short run levels of output and employment may vary from
the natural rates as a result of monetary factors, but in the
long run, the economy will always return to the natural
rates.
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Expectations-Augmented Phillips Curve
inflation
Natural Rate
5
2
4
SRPC(2)
1
3
2
SRPC(1)
1
U1
U*
Unemployment
SRPC(0)
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Another view:
Keynesian Perspective
AS2
AS1
3
2
1
AD2
AD1
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Policy Implications
Milton Friedman. “The Role of Monetary Policy,” American Economic
Review (March 1968), 1-17.
 Different Phillips curves exist for different inflation rates
 Changes in inflation expectations shift the short-run Phillips
curve.
 Any tradeoff from a single change in the money supply is shortrun. Any improvement in the economy due to such monetary
stimulus is brief at best, and leads to long-run inflation.
 To achieve a permanent reduction in unemployment via monetary
policy would require continuously increasing the money supply,
leading to infinite inflation, and the destruction of the economy.
(The accelerationist hypothesis.)
 To change the natural rate of output requires real sector changes.
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Natural Rate:
More Recent Work
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Friedman had argued that the natural rate would
be related to the actual structural characteristics
of the commodity and labor markets.
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Modern theory relates these characteristics to
those which determine frictional and structural
unemployment:
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What would affect people getting information and
making adjustments to their economic positions (asking
for raises, etc.)
Information costs and impediments to job search
Training
Natural rates are “time-varying” not “fixed and
permanent”.
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