Phillips Curve

11 Key excerpts on "Phillips Curve"

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  The Economics Companion

  • Graham Mallard(Author)
  • 2017(Publication Date)
  • Red Globe Press

    (Publisher)

  In the 1960s Robert Solow and Paul Samuelson showed the relationship to hold more generally between the rates of inflation and unemployment, which led to the conventional Phillips Curve displayed in Figure 11.7b. Key term: the Phillips Curve The Phillips Curve shows a negative association between the rates of inflation and unemployment of an economy. The implication of the Phillips Curve is that the government can choose which combination of inflation and unemployment prevails in the economy. If 223 unemployment, money and inflation 3 3 it thinks the inflation rate is too high it can reduce it, but at the cost of greater unemployment. Likewise, if it thinks unemployment is too severe it can reduce it, but at the cost of greater inflation. By integrating the Phillips Curve relationship into our analysis of the previous section, we can enrich our conclusions. To do so, though, we need to transform the conventional Phillips Curve. Instead of measuring the unem-ployment rate on the horizontal axis we need to plot the relationship in terms of the economy’s output level, which creates the mirror image of the curve in Figure 11.7b. The combined model is displayed in Figure 11.8. The upper panel shows both a recessionary and inflationary gap, caused by the aggregate demand curve shifting to AD 1 and AD 2 respectively. The lower panel displays the horizontally inverted Phillips Curve, which shows the change in the price level caused by a recessionary gap is less than that caused by an inflationary gap of equal size. The inflation caused by the inflationary gap, denoted by ˙ P 2 , is larger in absolute terms than the deflation caused by the recessionary gap, denoted by ˙ P 1 . This is one reason why economists tend to focus on inflation: it can become a serious problem quickly. We can now include the role of inflationary expectations into the analysis: the level of inflation that actors within the economy expect to prevail.

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  An Introduction to Economic Dynamics

  • Ronald Shone(Author)
  • 2001(Publication Date)
  • Cambridge University Press

    (Publisher)

  6.1 The Phillips Curve Most discussions of inflation begin with the Phillips Curve, and we shall be no exception. We shall, however, concentrate on those aspects that are important for the dynamics of inflation and unemployment. There are basically two spec-ifications for the Phillips Curve: the basic one relating inflation to unemploy-ment, and the expectations-augmented Phillips Curve, which relates inflation to unemployment and expected inflation. In general terms these are f ( u ) f ( u ) e where inflation, e expected inflation and u unemployment. For the moment, we shall assume a simple inverse relationship between inflation and unemployment, i.e. we assume a 0 a 1 u a 0 , a 1 0 It is not our intention here to present a full discussion of the Phillips Curve, and we simply state that the natural level of unemployment, u n , is the value of unemployment which satisfies the condition f ( u n ) 0 and e . Given our linear Phillips Curve, then u n satisfies the condition u n The situation is illustrated in figure 6.1, where we have drawn an expectations-augmented Phillips Curve. Of course, to draw such a Phillips Curve we must assume that expected inflation is given, which we shall do for the moment. In more recent treatments of the Phillips Curve it has been convenient to specify the relationship between inflation and the level of real income. This is because we need to include the Phillips Curve into a broader model of the macroeconomy. This takes the form ( y y n ) e 0 where y is real income and y n is the natural level of income associated with u n . But underlying this relationship are two reaction functions, which are worth spelling out. The first is a slightly reformulated Phillips Curve that relates infla-tion to the unemployment gap, i.e. 1 ( u u n ) e 1 0 a 0 a 1 (6.1) (6.2) (6.3) (6.4) 110 Chapter 6 Inflation–unemployment dynamics The second is Okun’s law, which relates the unemployment gap to the income gap, i.e.

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  Asymmetry and Aggregation in the EU

  • D. Mayes, Matti Virén(Authors)
  • 2011(Publication Date)
  • Palgrave Macmillan

    (Publisher)

  77 4 The Phillips Curve The Phillips Curve provides the key link between the real economy and inflation and lies at the heart of our analysis. Although there are various asymmetries involved in the relationship the most obvious facet is that the relationship is referred to as a curve. Although in many models it is estimated as a linear relationship in part because of the difficulties that Phillips himself encountered in the original estimation (Phillips, 1958). Indeed it is only partly an accident of history, with the collapse of the long-run regularity and its replacement with a short-run expectations augmented curve (Phelps, 1967), that it has frequently been estimated as a straight line. 1 In Phillips’ original specification, the rate of change of money wages is related to the rate of unemployment and described as a regularity without any formal attempt at a firm theoretical basis. Since then, in addition to including price expectations following Phelps (1967) and Friedman (1968) and later rational expectations (Lucas, 1976), the ten- dency has been to replace wage inflation with price inflation and fre- quently to use the output gap instead of unemployment as a measure of the pressure in the economy. We deliberately do not take a stand on what is the most appropriate specification. In Paloviita and Mayes (2006), we have examined a number of common versions of the models including expectations from the ‘new classical’ model using last period’s expectations to the ‘pure’ New 1 The discussion of the Phillips Curve remains contentious. Gordon (1997) main- tains that it is ‘resolutely linear’ in the US while Stiglitz (1984) suggests that it could have the opposite curvature with firms being more reluctant to raise rather than lower prices. Yates (1998) offers a helpful classification of the main different factors that could lead to nonlinearity. Keynesian model, which uses this period’s expectation of future inflation.

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  Macroeconomic Policy Since the Financial Crisis

  • Matteo Iannizzotto(Author)
  • 2023(Publication Date)
  • Agenda Publishing

    (Publisher)

  3 Behind the three equations II: inflation and the Phillips Curve

  3.1 Inflation and the Phillips Curve

  It must be remembered that the Phillips Curve is first and foremost an empirical relationship that was originally meant to relate wage inflation and unemployment (Phillips 1958 ). Ever since it has been in search of a theoretical justification that has come in different guises and sometimes these have also been radically different. In the context of the three-equations model (or the DSGE) it is meant to represent the behaviour of inflation relative to some measure of the output gap. Stripped of all deeper theoretical foundations, that is its bare purpose. Inevitably, when one examines what lies behind it, one is forced to examine inflation per se. It is in the treatment of this crucial economic variable and the Phillips Curve that purports to represent it, that the greatest and deepest discrepancies will be found between the three-equations model and the DSGE. But in order to see this in greater detail, some general questions about inflation will have to be addressed.

  In its barest form, inflation just means a positive rate of growth in prices. How it comes about and what justifies it can be done in different ways. In particular a general distinction can be made between demand-pull and cost-push inflation. The first case, in intuitive terms is when demand outstrips supply and prices have to rise. Another way of looking at it is to say that it is a case of excess demand. These instances have already been represented in the diagrams of the first chapter in all the cases where the first shock was one on the IS curve (permanent or temporary) making it true that current output would exceed equilibrium (or otherwise put, the output gap is positive). Consistently with the specification of the Phillips Curve, the positive output gap on the right-hand side causes inflation to rise on the left-hand side.1

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  Inflation Dynamic

  Global Positive Economic Analysis

  • Weshah Razzak(Author)
  • 2023(Publication Date)
  • Routledge

    (Publisher)

  8  The Phillips Curve, Anticipated Inflation, and Output

  DOI: 10.4324/9781003382218-8

  Abstract

  We discuss the evolution of and the theoretical issues surrounding the Phillips Curve, which was originally (Phillips, 1958 ) a negative empirical relationship between the unemployment rate and the inflation rate. It has been the dominant theory of inflation in central banks in developed countries. Policymakers and politicians seem to like the idea that they could influence the economy by exploiting this relationship, that is, in order to create more employment, they inflate the economy. By late 1960s and through the 1970s, more theoretical analyses showed that such exploitation is fruitless because unanticipated aggregate demand shocks, that is, surprises, ignored by Phillips, is the only significant determinant of real output. Anticipated aggregate demand shocks, on the other hand, are ineffective in stimulating the economy. Every time the monetary authority attempts to stimulate demand, it increases real output (reduces unemployment) in the short run, then inflation expectations shift up the Phillips Curve, and real output (unemployment) returns to their long-run equilibrium before the policy change. If the monetary authority continues to stimulate the economy, the Phillips Curve keeps shifting up via expectations effects, and, in the long-run, the economy ends up with more inflation and no change in real output or unemployment; hence the Phillips Curve is vertical in the long run, and no trade-off between inflation and output (unemployment) exists. Our Sample Generalized Variance tests indicate that the New Keynesian specification, change in inflation–output gap, is unstable in most of the 42 countries in our sample.

  Monetary theories of inflation are contentious. There are stark differences of opinions between economists about the determinants of inflation. So far, we have only analyzed the QTM, where in the long run, inflation is caused by, or is highly correlated with, the growth rate of the quantity of money per unit of real output. Remember that we define inflation as a continuing increase in the price level, and the difference between the short run on one hand and the long run

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  Income Distribution Theory

  • Martin Bronfenbrenner(Author)
  • 2017(Publication Date)
  • Routledge

    (Publisher)

  Chapter 10 , section 14.

  Such an inverse relation as the Phillips Curve is plausible on grounds of either economic theory or bargaining theory. We introduced it in Chapter 10 as an aspect of the incidence of collective bargaining. However, for any commodity x with price p = f (x ) in a purely competitive market, the Samuelson condition of dynamic stability of the relationship f (x ) is that

  where t is time, λ is a positive constant, and

  Ex

  is the excess demand for x (quantity demanded less quantity supplied) at price p .

  If we rewrite the last expression in terms of a wage rate w and a quantity of labor a , and introduce a positive technical improvement or productivity increase factor

  w0

  :

  Let

  Ea

  be the excess demand for either some special sort of “standard” labor or for “standard” labor in the aggregate. Even so, the condition

  Ea

  = 0 is consistent with considerable unemployment of substandard labor (uneducated, inexperienced, handicapped, subject to discrimination). It is therefore consistent also with a positive measured unemployment rate, especially if no allowance is made for unfilled job vacancies. The measured unemployment rate also include the “frictional” unemployment of workers changing jobs.

  On a diagram like Figure 11.6 (redrawn from Figure 10.3 ), the horizontal line A may serve as an estimate of

  w0

  , with

  Ea

  = 0. It also represents the annual rise in average and marginal labor productivity, and hence the maximum wage increase consistent with price stability in the absence of functional income redistribution in favor of labor. The vertical line B , it will be remembered, is the maximum “politically feasible” unemployment level, and F is the intersection of the A and B lines. The P 0 and

  Px

  functions of Figure 10.3 are two-dimensional31 Phillips Curves and serve as estimates of w in (11.5)

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  Applied Intermediate Macroeconomics

  • Kevin D. Hoover(Author)
  • 2011(Publication Date)
  • Cambridge University Press

    (Publisher)

  614 The Dynamics of Output, Unemployment, and Inflation 6. Price-setting firms choose optimal prices relative to the general price level. In order to achieve the desired relative price, they must set prices in antici-pation of future inflation. The relative prices of the goods they produce are likely to be modified to take account of cost pressures (supply) or demand pressures. 7. The (expectations-augmented) Phillips Curve aggregates the price-setting behavior of firms to find a relationship between inflation, relative to expected inflation, and a measure of aggregate demand (aggregate-supply factors may also be considered). Aggregate demand (relative to aggregate supply) is often measured by the unemployment rate. The Phillips Curve may be written as: ˆ p t − t − 1 ˆ p e t = − β ( U t − U ∗ ) + g ( aggregate-supply factors t ), where U ∗ is the natural rate of unemployment , defined as the rate that keeps actual and expected inflation in agreement. 8. Expectations are frequently measured on the assumption that this period’s infla-tion rate will be the same as last period’s. Then the Phillips Curve may be written as: ˆ p t = − β ( U t − U ∗ ) + g ( aggregate supply t ). In this version, U ∗ is frequently referred to as NAIRU , the non-accelerating inflation rate of unemployment. 9. Other measures of aggregate demand relative to supply can be used in the Phillips Curve, such as scaled output. Then NAIRU would be interpreted to mean non-accelerating inflation rate of resource utilization. 10. NAIRU (or the natural rate of unemployment) is not constant over time, but may vary with changes in real factors, such as demographics or the organization of labor markets. 11. The role of expectations in the Phillips Curve highlights the importance of cred-ibility in demand-management policy: reducing inflation is less costly in terms of unemployment or other unused resources if the public believes that policy-makers will actually be successful in reducing it.

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  Multimod Mark III : The Core Dynamic and Steady State Model

  • Hamid Faruqee, Douglas Laxton, Bart Turtelboom, Peter Isard, and Eswar Prasad(Authors)
  • 1998(Publication Date)
  • INTERNATIONAL MONETARY FUND

    (Publisher)

  50 Passage contains an image

  Specification of the Mark III Phillips Curve

  The Phillips Curve in Mark III follows closely on the heels of some recent empirical work that has extended an estimation methodology proposed in Debelle and Laxton (1997 ) and applied to a fairly large group of industrial countries.51 The empirical strategy is based on developing model-consistent measures of labor market tightness from the following convex functional form:

  where u is the unemployment rate, u * is the DNAIRU, and γ and φ are parameters to be estimated.52 Box 6 follows Faruqee, Laxton, and Rose (1998 ) in providing a derivation of the convex Phillips Curve that is based on extending the model of Layard, Nickell, and Jackman (1991 ).

  The Phillips Curve represented by equation (8) has two asymptotes, at u = φ and π − πe = −γ, as shown in Figure 1 . The first represents the minimum level of unemployment where the short-run Phillips Curve becomes vertical. The second asymptote, −γ, represents the point where marginal increases in unemployment have no additional downward effects on the inflation process. This is the region of extreme diminishing marginal effectiveness where a marginal tightening of macroeconomic policies mainly affects unemployment with little impact on the inflation process.

  One can think of the NAIRU, or in Figure 1 , as Friedman's (1968 ) concept of the “natural” rate, on the grounds that, for given institutions and stabilization policy rules, this is the rate that is “ground out” on average by markets. It may be noted, as well, that data observed in a stochastic world do not yield direct estimates of the DNAIRU, u

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  Brookings Papers on Economic Activity: Spring 2019

  • Janice Eberly, James H. Stock, Janice Eberly, James H. Stock(Authors)
  • 2019(Publication Date)
  • Brookings Institution Press

    (Publisher)

  Romer expressed his belief that this piece is crucial to “saving” the Phillips Curve, but that it lacks any substantive microeconomic foundations. Macroeconomic models get around this problem by assuming that workers index their wages to some abstract concept of expected inflation, but this assumption has little basis in reality. As a result, he argued that economists are still a long way from explaining why and how inflation expectations actually matter for inflation, and therefore from understanding the behavior of inflation. Robert Hall complimented the paper on its litany of data on entrance and exit rates from unemployment. He noted though that the paper’s conceptual reliance on the Phillips Curve goes against data showing it to be an unreliable predictor of inflation. He cited a paper by James Stock and Mark Watson, as well as Phillips Curves used in work by Robert Gordon as better examples. 1 These formulations of the Phillips Curve study changes in unemployment relative to changes in inflation rather than the relationship between the level of unemployment and inflation and do a better job of fitting the data. He also referenced a paper he wrote with Thomas Sargent on the failure of the modern Phillips Curve due to its misunderstanding of Milton Friedman’s original ideas about the construct. 2 He noted specifically that Sargent had been critical of it since the 1960s. 1. James H. Stock and Mark W. Watson, “Modeling Inflation after the Crisis,” Proceed-ings: Economic Policy Symposium—Jackson Hole, Federal Reserve Bank of Kansas City , 173–220, https://www.kansascityfed.org/publicat/sympos/2010/Stock-Watson_final.pdf; Robert J. Gordon, “The Phillips Curve Is Alive and Well: Inflation and the NAIRU during the Slow Recovery,” NBER Working Paper 19390 (Cambridge, Mass.: National Bureau of Economic Research, 2013), https://www.nber.org/papers/w19390.pdf.

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  Introductory Macroeconomics

  • Michael Veseth(Author)
  • 2014(Publication Date)
  • Academic Press

    (Publisher)

  All this spending created even more prosperity (as factories hired more workers to meet rising demand), but it also bid up prices (in the next chapter, we will refer to this situation as demand-pull inflation). These rapid increases in spending generate the Phillips Curve phe-nomenon observed in the 1960s. The inflation of the 1970s was caused by scarcity, not prosperity. With oil—then oil and credit—scarce, prices pushed up, forcing consumers to cut back spending. This cost-push inflation gives us both inflation and unemploy-ment. The Phillips Curve formula breaks down. A second explanation of the Phillips Curve's demise is based on the wage-lag theory discussed a few pages ago. This theory suggests that wages tend to lag behind price increases, generating short-term profits that encourage busi-nesses to hire more workers. This explanation of the Phillips Curve only holds, however, if wages do, in fact, lag behind prices—if inflation is a surprise. If workers are sophisticated about inflation, the Phillips Curve stops working. Workers negotiate higher and higher wage increases in anticipation of higher prices at the grocery store and gas pump. Wages no longer lag behind prices. Indeed, it might work the other way, forcing business firms to lay off workers if prices do not rise fast enough to cover contractual wage increases. The Phillips Curve is down, but it is not out. It is easy to find phantom Phillips Curves in the 1970s (look, for example, at the period of 1977-1980 in Figure 1-5). The only thing clear here is that there is more going on than just the Phillips Curve. The trade-off between inflation and unemployment is not as clearly defined as economists once thought. The 1980s and Beyond Ronald Reagan became the second U.S. president with an economics degree (of course, he went to college a loooong time ago).

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  Macroeconomic Theory and Macroeconomic Pedagogy

  • G. Fontana, M. Setterfield, G. Fontana, M. Setterfield(Authors)
  • 2016(Publication Date)
  • Palgrave Macmillan

    (Publisher)

  Two post-shock IS curves are shown in the upper panel of Figure 1.7: the more-interest sensitive one is the flatter one labelled IS . The consequence of output above y e is that inflation rises above target – in this case to 4% (point B). This defines the Phillips Curve (PC(π I = 4)) along which the central bank must choose its preferred point for the next period: point C. The desired level of aggregate demand depends only on the aspects of the economy depicted in the Phillips diagram, i.e. the supply side and the central bank’s preferences and hence is the same for each economy. However, by going vertically up to the IS diagram, we can see that the central bank must raise the interest rate by less in response to the shock if aggregate demand is rather responsive to a change in the interest rate (as illustrated by the flatter IS curve). 2.5 How central bank inflation aversion and the slope of the Phillips Curve affect interest rate decisions To investigate how structural features of the economy such as the degree of inflation aversion of the central bank and the responsiveness of inflation to the output gap impinge on the central bank’s interest rate decision, we look at the central bank’s response to an inflation shock. A one-period shift in the Phillips Curve could occur as a result, for example, of an agricultural disease outbreak that temporarily interrupts supply and pushes inflation above the target level. We focus attention on the consequences for monetary policy of different degrees of inflation aversion on the part of the central bank (β) and on the 28 Teaching Intermediate Macroeconomics r S r'' MR AD A, Z B C A' C' Z' y' y e 4 π r S ' B' IS' IS'' r S '' r' PC (π I 4) PC (π I 2) π T 2 y r 1 IS Figure 1.7 The monetary policy response to a permanent IS shock: the role of the slope of the IS curve responsiveness of inflation to output as reflected in the slope of the Phillips Curve (α).

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