Posted on July 31, 2022
The Phillips Curve did well for a while – but all this changed in the 1970s, a period of high unemployment and high inflation. This phenomenon was obviously incompatible with the received reasoning of the Phillips Curve. How then is one to explain this?
It had been the fresh new subequent observance that was disturbing: in case the Phillips Contour is really moving, then relationships anywhere between inflation and you can unemployment is not actually good negative one
A good way, followed by of many Keynesians, are just to believe the newest Phillips Bend was “migrating” for the an effective northeasterly advice, so a level of unemployment are regarding large and better levels of rising cost of living. However, as to the reasons? Yes, there are of several factors for it – as well as some imaginative. As the major excuse with the Phillips Curve are mainly the empirical veracity rather than a theoretical derivation, after that what’s the point of one’s Phillips Curve when it no longer is empirically true? A great deal more pertinently to own policy-providers, a migrating Phillips Contour is perhaps not plan-effective: for the Phillips Contour moving forward doing, then rising prices price of focusing on a particular jobless price was perhaps not demonstrably identifiable.
Milton Friedman (1968) and you can Edmund Phelps (1967) rose towards celebration in order to propose a hopes-enhanced Phillips Contour – that was following contained in the newest Neo-Keynesian paradigm by James Tobin (1968, 1972). The brand new Neo-Keynesian tale will be thought of as pursue: assist aggregate affordable demand be denoted D, so that D = pY.
or, letting gD = (dD/dt)/D and accordingly for the other parameters and letting inflation gp be denoted p , then we can rewrite this as:
so price inflation is driven by nominal demand growth (gD) and output/productivity growth (gY). Now, assuming the standard Keynesian labor market condition that the marginal product of labor is equal to the real wage (w/p), then dynamizing this:
where gw is nominal wage growth, so the ically. Expressing for p and equating with our earlier term then we can obtain:
we.age. nominal wage rising cost of living is equal to moderate aggregate request growth. Today, the fresh Friedman-Phelps proposition to possess criterion enlargement is actually proposed because:
so wage inflation is negatively related to the unemployment rate (U), so that h’ < 0 as before, positively to productivity growth (so a > 0) and positively with inflation expectations, p e (so b > 0). Let us, temporarily, presume productivity growth is zero so that gY = 0. In this case, gw = p (so note that the real wage is constant) so that this can be rewritten:
which is simply the standards-augmented Phillips Curve, because shown within the Figure fourteen. The term b ‘s the criterion eter (particularly, b is the rates where standard is adjusted in order to actual experience). For this reason, p e = 0 (hopes of zero rising prices), you will find the old p = h(U) curve intact. However if you will find self-confident inflationary standards ( p elizabeth > 0), then it contour changes right up, given that found in the Figure 14.
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If workers expect inflation to increase, then they will adjust their nominal wage demands so that gw > 0 and thus p > 0. It is assumed, in this paradigm, that 0 < b < 1 - not all expectations are carried through. So, for each level of expectations, there is a specific "short-run" Phillips Curve. For higher and higher expectations, the Phillips Curve moves northeast. Thus, the migration of the so-called "short-run" Phillips Curve (as in the move in Figure 14) was explained in terms of ever-higher inflationary expectations. However, for any given level of expectations, there is a potential trade-off (as a matter of policy) between unemployment and inflation.