Short-Run Phillips Curve

12 Key excerpts on "Short-Run 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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  Routledge Encyclopedia of International Political Economy

  • R. J. Barry Jones(Author)
  • 2002(Publication Date)
  • Routledge

    (Publisher)

  Phillips. The Phillips Curve inverse relationship suggests that there is a trade-off between inflation and unemployment: higher inflation rates are the price, in the short-run, of policies that reduce the unemployment rate. The apparent existence of the Phillips Curve trade-off caused economists in the 1960s to adopt a decidedly activist and Keynesian stance towards macro-economic policy. It was thought that fiscal and monetary policies could be finely tuned to deal with changing economic conditions. If inflation rose too high, tighter monetary policy could bring it down (albeit at the cost of an increase in joblessness). If unemployment was too large, expansionary policies could be used to create jobs (although at a cost of higher inflation). Balancing inflation against unemployment, an activist government could prevent either problem from getting out of hand. The idea of the Phillips Curve trade-off not only encouraged activist government policies, it also helped create a particular political econ-omy of inflation. Special interests seeking benefits from the government could gain jobs, for example, by advocating policies that were paid for through an inflation tax on other agents in the economy. It was in the interests of politicians and policy-makers to accommodate special interest pressures, since they would get credit for the specific benefits but could avoid blame for the general inflation costs. The existence of concentrated benefits (jobs or government payments) and highly diffused costs (the indirect effects of inflation) encour-aged further special interest pressure, which succeeded by further raising the price-level. The political system was biased in favour of special interests and inflation, according to this analysis. The monetarist critique of the Phillips Curve observes that the trade-off between inflation and unemployment appears to be at best temporary.

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  Macroeconomics

  (With Study Guide CD-ROM)

  • Jagdish Handa(Author)
  • 2010(Publication Date)
  • WSPC

    (Publisher)

  Figure 10.3b .

  10.10 Phillips Curve (PC)

  In 1958, A.W. Phillips plotted the rate of change of nominal wages against the rate of unemployment for the U.K. over several periods from 1861 to 1957, and found that the data showed a downward sloping curve. His original plotted relationship was of the form

  where W″ is the rate of increase of the nominal wage rate, u is the actual rate of unemployment, and dW′/du 0 indicates that the rate of increase of nominal wages falls as unemployment rises. This occurs because a higher unemployment rate weakens workers’ bargaining power relative to that of firms. Therefore, the unemployment-wage relationship is of the form shown in Figure 10.3a , which has the rate of change in nominal wages W ″ on the vertical axis and the actual rate of unemployment u on the horizontal one. The estimated forms of this curve proved to be convex to the origin, i.e., decreases in unemployment cause successively greater increases in nominal wages.19 This relationship soon evolved into its inverse — that is, u = f(W″) — and then into a relationship of the form

  where π is the rate of inflation and du/dπ 0. This equation is called the Phillips curve (PC) equation and is drawn as the curve PC in Figure 10.3b , with the rate of inflation π on the vertical axis. The PC states that increases in the inflation rate reduce the unemployment rate. Its convex shape indicates that at higher inflation rates, further increases in inflation produce smaller decreases in unemployment.

  The transition between the above two equations comes from the link between the nominal wage rate and inflation: nominal wages represent the main element of the cost of production so that an increase in nominal wages will induce firms to increase their prices; alternatively, an increase in prices causes labor to ask for compensation in the form of wage increases. Hence, there is a positive relationship between W″

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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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  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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  Macrodynamics: Fluctuations and Growth

  A study of the economy in equilibrium and disequilibrium

  • Pierre-Yves Hénin(Author)
  • 2013(Publication Date)
  • Routledge

    (Publisher)

  22 The coefficient a expresses the proportion of anticipated inflation incorporated into the current rate of growth of prices and wages. A more comprehensive analysis of the ‘expectations-augmented’ Phillips curve requires some explanation of the process of expectations formation. The above expression is valid in the short term for a given anticipated inflation rate, while in the long term it is assumed that expectations are realised, so that

  The gradient of the long-run Phillips curve is greater than that for the short run, which implies that the cost in terms of inflation of reducing unemployment is increased. In the limit, with absence of money illusion and full carry-through of anticipated inflation, the coefficient α equals one, and the Phillips curve is vertical. It is then no longer possible to obtain a permanent reduction in unemployment by allowing a higher level of inflation.

  Figure 11.9

  Figure 11.10

  There exists a family of Short-Run Phillips Curves, whose level is a function of anticipated inflation and which in the long term, with endogenous, equal to the actual inflation rate, gives way to a vertical line. The unemployment rate u

  n

  is then compatible with any rate of inflation. If it be allowed that anticipated inflation follows actual inflation with some degree of inertia, the accelerationist theory may be established. The simplest expectations formation process which includes such inertia is the static process , for which the augmented Phillips curve, while maintaining the assumption of absence of money illusion, becomes:

  The trade-off is now no longer between unemployment and inflation, but between unemployment and the acceleration of inflation, whence the name ‘accelerationist’ given to this theoretical approach.23

  The only rate of unemployment consistent with a constant inflation rate is u

  n

  , called by Friedman the ‘natural rate’ of unemployment. Defining a function h over the gaps , between the current unemployment rate and the natural rate, we have:

  and

  The first expression, general for α

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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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  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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  Macroeconomic Theory: A Short Course

  A Short Course

  • Thomas R. Michl(Author)
  • 2015(Publication Date)
  • Routledge

    (Publisher)

  10.5: Starting from a long-run equilibrium (A), an increase in the rate of growth of the money supply from 5 per cent per year to 6 per cent per year causes the system to move along its Phillips curve in the short run (B). Because inflation expectations chase after actual inflation, next year’s equilibrium lies on the new Phillips curve (C). Ultimately, the system will achieve the new long-run equilibrium (D). The arrow shows the path taken when the model has a stable focus, which involves overshooting the equilibrium.

  In its first period, the policy moves the economy along its existing Phillips curve. Since workers follow adaptive expectations, they believe that the inflation rate will remain at its original level (the old long-run equilibrium inflation rate).

  In its second period, the policy works through both dynamic processes we described above. The Phillips curve shifts upward because the expected rate of inflation, which positions the Phillips curve, chases after the actual rate of inflation, which rose in the first year. The unemployment rate in Figure 10.5 has continued to decline, because the inflation rate is still below the new growth rate of the money supply set by the central bank.

  At some point in time, the economy will reach a turning point where the unemployment rate will cease dropping and begin to rise. This will occur when the inflation rate rises above the growth rate of the money supply. The Phillips curve will then be shifting upward and the unemployment rate will be rising, so that inflation and unemployment increase simultaneously, a phenomenon known as stagflation. The ability of the expectations-augmented Phillips curve to explain the stagflation of the 1970s played a major role in its acceptance by the economics profession.

  Another turning point is reached when the unemployment rate rises above the natural rate of unemployment. As we have seen, in this configuration the Phillips curve shifts downward over time because inflation expectations overestimate inflation, and are being revised downward. The economy experiences falling inflation and rising unemployment until the next turning point is reached.

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  Macroeconomic Theory and Macroeconomic Pedagogy

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

    (Publisher)

  If, in addition, the response of inflation to output is lagged, the central bank will have to forecast the Phillips curve a further period ahead and the Taylor Rule will take its familiar form to include contemporaneous inflation and output shocks. The 3-equation (C–S) model provides access to contemporary debates in the more specialized monetary macroeconomics literature. As shown in Carlin and Soskice (2005), it is straightforward to demonstrate the origin of the time-inconsistency problem using the graphical approach. All modelling in economics needs to be taken with a pinch of salt. Our purpose is to provide a simple tool-kit for analysing most common situa- tions. Three concluding remarks are important: (1) In this chapter, we do not discuss in any detail how y e is derived: the example shown in Figure 1.5 indicates how changes in the real cost of raw materials, including food and energy, are reflected in the interaction of price-setting and wage-setting real wage curves. The structural effects of tax changes can be shown in a similar way, as can shifts in productivity and institutional and policy characteristics of the labour and product markets. (2) Autonomous demand A is proba- bly the most difficult component to forecast particularly when household and business expectations are changing. And the ability of the CB to ‘pick’ future output by current changes in r is most suspect under such volatile conditions. Finally (3) the chapter focuses on the closed economy. Although we have introduced the analysis of an oil price shock, we have not pre- sented a full model of the open economy to include the role of exchange rate determination. As we show in our textbook (2006), the role of the real exchange rate in the open economy leads to some important changes in analysis. Appendix 1.1 The central bank’s loss function: graphical representation The geometry of the central bank’s loss function can be shown in the Phillips curve diagram.

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  Economics of Transition

  A New Methodology for Transforming a Socialist Economy to a Market-led Economy

  • Hüsnü Kizilylli(Author)
  • 2019(Publication Date)
  • Routledge

    (Publisher)

  Similarly when an unanticipated decline in aggregate demand occurs and real prices and wages increase unexpectedly and as a consequence a temporary surplus of labor and goods emerges, a rational firm, in lieu of reducing output and laying off redundant workers (which is a costly and painful exercise itself), would rather reduce its prices which would restore demand and to tackle with the reduced profit margin due to high wage costs, could renegotiate wages and workers, under the threat of losing their jobs would rather accept lower wages, as they did in the early 1980s in the US. Or the firm after lowering its prices could well decide to absorb the extra wage cost element, depending on circumstances, in order to keep its market share, and considering also that it will re-hire the same workers when real wages decline to their normal level. The firm might take this opportunity to get rid of inefficient workers, but then it will shortly have to restore employment and output.

  Moreover reducing output and employment in the face of unanticipated demand fall assumes closed economy and no competition in oligopolistic markets, whereas even colluding oligopolistic firms would undercut competitors when opportunities arise. This situation gives a good opportunity to do so, particularly for the firm which successfully re-negotiated the new wage level. In an open economy, overpriced products would invite foreign competition and import penetration into the market will increase and a rational firm has to protect its market share against such eventuality.

  6 Empirical evidence for the Phillips curve trade-off

  Empirical evidence showing that in the short-run an increase in the money stock affects primarily output and has little effect on inflation (prices or wages) is considered as solid support for the short-term Phillips curve. E.g. the Data Resources Inc. macroeconometric model for the US economy shows that 0.5% monetary expansion (in real balances) would at the beginning cause output to rise with almost no impact on prices; “only after a year does output start falling back as prices increases build up and bring real balances back down: but even after 16 quarters or 4 years, output is still above its initial level and prices have not risen by a full percentage point”. This is considered as empirical evidence for the Phillips curve trade-off, since due to gradual adjustment of wages (sticky wages), a monetary expansion had a lasting effect on output and employment (Dornbusch and Fischer, 1990, pp. 480-81). Following comments can be made on these views:

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