Lecture8_PhillipsCurve

# Lecture8_PhillipsCurve - EC3024 Managerial Macroeconomics...

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EC3024 Managerial Macroeconomics The Phillips Curve, the Natural Rate of Unemployment, and Inflation

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The Phillips Curve The Phillips curve , based on the data above, shows a negative relation between inflation and unemployment. Inflation versus Unemployment in the United States, 1900 to 1960 Figure 8 - 1 2
Inflation, Expected Inflation, and Unemployment The aggregate supply relation can be rewritten to establish a relation between inflation, expected inflation, and the unemployment rate. First, the function F , assumes the form: Then, replace this function in the one above: The appendix to Chapter 8 shows: 3 P P F u z e ( ) ( , ) 1 F u z z ( , ) 1 u P P e ( ) ( ) 1 1 u + z e z ( ) u

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An increase in the expected inflation, e , leads to an increase in inflation, . Given expected inflation e , an increase in the markup, , or an increase in the factors that affect wage determination, z, lead to an increase in inflation . Given expected inflation, e , an increase in the unemployment rate, u, leads to a decrease in inflation, . Inflation, Expected Inflation, and Unemployment 4 e z ( ) u
Inflation, Expected Inflation, and Unemployment When referring to inflation, expected inflation, or unemployment in a specific year, the equation above needs to include time indexes, as follows: The variables , e t , and u t refer to inflation, expected inflation and unemployment in year t . and z are assumed constant and don’t have time indexes. 5 e z ( ) u e t t t z u

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When e t = 0, then: This is the negative relation between unemployment and inflation that Phillips found for the United Kingdom, and Solow and Samuelson found for the United States (or the original Phillips curve). 6 The Original Phillips Curve t t z ( ) u
The wage-price spiral : Given P e t = P t-1 : Low unemployment leads to a higher nominal wage. In response to the higher nominal wage, firms increase their prices and the price level increases. In response, workers ask for a higher wage. Higher nominal wage leads firms to further increase prices. As a result, the price level increases further. This further increases wages asked for by workers. And so the race between prices and wages results in steady wage and price inflation. 7 The Original Phillips Curve u W P P P P t t t t t t t 1 1

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The steady decline in the U.S. unemployment rate throughout the 1960s was associated with a steady increase in the inflation rate. Inflation versus Unemployment in the United States, 1948 to 1969 Figure 8 - 2 8 Mutations
Beginning in 1970, the relation between the unemployment rate and the inflation rate disappeared in the United States.

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