az.301.ch8.phillips.ppt

az.301.ch8.phillips.ppt - The Phillips Curve Understanding...

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Unformatted text preview: The Phillips Curve Understanding Understandingthe theRelationship RelationshipBetween BetweenInflation Inflationand and Unemployment Unemployment Blanchard: Macroeconomics Chapter 8: The Phillips Curve-The Medium Run The Phillips Curve-Understanding the Relationship Between Inflation and Unemployment • An inverse relationship between inflation and unemployment until the 1970s • 1970s high inflation and unemployment • Is there still a relationship between inflation and unemployment? Blanchard: Macroeconomics Chapter 8: The Phillips Curve-The Medium Run The Phillips Curve – Understanding Inflation, Expected Inflation, and Unemployment From our wage setting – price setting model: Wt = PteF(ut,z) and Pt = (1+µ) Wt Lets assume that F(ut,z) = 1- ut+z Then Pt = Pte(1+µ)F(ut,z) Blanchard: Macroeconomics Chapter 8: The Phillips Curve-The Medium Run The Phillips Curve – Understanding Inflation, Expected Inflation, and Unemployment From Pt = Pte(1+µ) (1- ut+z) We can derive t = t e + (µ+z)- ut where t = the inflation rate t e = the expected inflation rate Blanchard: Macroeconomics Chapter 8: The Phillips Curve-The Medium Run The Phillips Curve – Understanding Inflation, Expected Inflation, and Unemployment Observations: Observations: tt == ttee ++ (µ+z) (µ+z) -- uutt •Higher expected inflation leads to higher inflation •Given expected inflation, the higher the µ or z, the higher inflation •Given expected inflation, the higher unemployment, the lower inflation Blanchard: Macroeconomics Chapter 8: The Phillips Curve-The Medium Run The Phillips Curve – Understanding Inflation, Expected Inflation, and Unemployment The TheEarly EarlyIncarnation, Incarnation, Circa Circa1960 1960 • Average inflation close to zero t e =O t = (µ+z) - ut Low unemployment leads to high wage increases leads to high price increases leads to high wage increases in a wage – price spiral. Blanchard: Macroeconomics Chapter 8: The Phillips Curve-The Medium Run The Phillips Curve – Understanding Inflation, Expected Inflation, and Unemployment The TheEarly EarlyIncarnation, Incarnation, Circa Circa1960 1960 Blanchard: Macroeconomics Chapter 8: The Phillips Curve-The Medium Run 1970s: 1970s: Why Why did did the the Phillips Phillips curve curve vanish? vanish? higher higheroil oilprices pricesincreased increased µµ and and inflation inflationbecame becamepersistent persistentand and positive positive Blanchard: Macroeconomics Chapter 8: The Phillips Curve-The Medium Run The Phillips Curve – Understanding Inflation, Expected Inflation, and Unemployment Inflation Inflation & & Expectations Expectations Blanchard: Macroeconomics Chapter 8: The Phillips Curve-The Medium Run The Phillips Curve – Understanding Inflation, Expected Inflation, and Unemployment Inflation Inflation & & Expectations Expectations Assume: : e t t 1 • the effect of last year’s inflation rate on this year’s expected inflation rate • the higher the value of , the higher the expected inflation rate Blanchard: Macroeconomics Chapter 8: The Phillips Curve-The Medium Run The Phillips Curve – Understanding Inflation, Expected Inflation, and Unemployment Mutations Mutations & & Expectations Expectations • 1900-1960: Inflation low and not persistent = 0, t e = t-1 = 0 and t = (µ+z) – ut (the normal Phillips Curve) Blanchard: Macroeconomics Chapter 8: The Phillips Curve-The Medium Run The Phillips Curve – Understanding Inflation, Expected Inflation, and Unemployment Mutations Mutations & & Expectations Expectations • 1970s: Inflation high and persistent started to increase to 1 t = t-1 + (µ+z) – ut ( t-1 = te ) • The inflation rate depends on: • The unemployment rate (ut) • Last year’s inflation rate ( Blanchard: Macroeconomics t-1 Chapter 8: The Phillips Curve-The Medium Run ) The Phillips Curve Understanding Inflation, Expected Inflation, and Unemployment Inflation Inflation & & Expectations Expectations When: t = t-1 + (µ+z) – ut and = 1 Aggregate supply = t – t-1 = (µ+z) – ut Therefore: The unemployment rate affects the change in the inflation rate High unemployment decreases inflation the inflation rate Blanchard: Macroeconomics Chapter 8: The Phillips Curve-The Medium Run Inflation Inflation & & Expectations Expectations 1970-1998: 1970-1998: tt –– t-1t-1 == 6.5% 6.5% –– 1.0u 1.0utt Blanchard: Macroeconomics Chapter 8: The Phillips Curve-The Medium Run The Phillips Curve – Back to the Natural Rate of Unemployment At At the the natural natural rate rate of of unemployment unemployment (u (unn):): The Theactual actualinflation inflationrate rate== expected expected inflation inflation rate rate tt ee == tt • Given: t – te + (µ+z) – un • Then: 0 = (µ+z) – un z un Blanchard: Macroeconomics Chapter 8: The Phillips Curve-The Medium Run The The Nonaccelerating Nonaccelerating Inflation Inflation Rate Rate of of Unemployment Unemployment (NAIRU) (NAIRU) Given: z un Then: un = µ + z Given: t = te + (µ+z) – ut Then: t = te + un – ut t – te = -(ut – un) Blanchard: Macroeconomics Chapter 8: The Phillips Curve-The Medium Run The Phillips Curve – A Summary and Many Warnings Summary: Summary: The AS relation: t – t-1 = -(ut – un) shows that: Inflation increases when ut > un Inflation decreases when ut < un However: the relation can shift Blanchard: Macroeconomics Chapter 8: The Phillips Curve-The Medium Run The Phillips Curve – Differences in the Natural Rate Across Countries t un L µ and z are assumed consistent Changes in u and z • The composition of the labor force • The structure of wage bargaining • Unemployment benefits • Can you think of others? Blanchard: Macroeconomics Chapter 8: The Phillips Curve-The Medium Run The Phillips Curve – Differences in the Natural Rate Across Countries The TheLimits Limitsof ofOur OurUnderstanding Understanding Europe Europein inthe the1990s 1990s Blanchard: Macroeconomics Chapter 8: The Phillips Curve-The Medium Run ...
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