The Phillips Curve

The Phillips Curve

The essence of the Phillips curve is that there are short-term trade-off between unemployment and inflation. But the Phillips curve has come under sustained attack the original - particularly monetary economists, and when we look at the data on unemployment and inflation in Britain over the past fifteen years, we will find that the nature of barter has definitely changed for the economy and other .. As well as

The basic Phillips Curve idea – economic trade-offs

At Philips AW 1958 and some of them take the Phillips curve drawing its name 95 years of wage inflation data in the United Kingdom against unemployment. Seems to suggest that the short-term trade-off between unemployment and inflation. Was behind this theory is fairly straightforward. The decline in the unemployment rate may cause high rates of inflation and the decline in the rate of inflation will only be possible by allowing unemployment to rise. If the government wants to reduce the unemployment rate, which would increase aggregate demand, but although this may temporarily increase employment, and they can also have inflationary effects in the labor and product markets.

The key to understanding the trade-off is to consider the potential effects of inflation in both labor and product markets arising from the increase in national income and output and employment.

The labour market:

As unemployment falls, there may be some shortages of labor, where skilled labor is in short supply. This puts additional pressure on wages to rise, because wages are usually a high proportion of total costs, prices may rise as companies pass these costs on to customers

Other factor markets:

Pay the costs of inflation can also come from the growing demand for commodities such as oil, copper and manufactured goods manufacturers such as concrete, steel and glass. When the economy is thriving, so does the demand for these components and raw materials.

Product markets:

High demand and production puts pressure on scarce resources and can lead to higher prices of suppliers to expand profit margins. Risk of high prices is greatest when demand is out stripping supply and capacity that lead to an increase in demand (ie, a positive output gap).

Explaining the Phillips Curve concept using AD-AS and the output gap

Let's look at the interpretation of the trade-off using the AD - AS analysis and the concept of the output gap. In the following graph, draw a vertical curve LRAS also - and this makes the assumption that the productive capacity of the economy in the long run is independent of the price level.

See a shift towards the outside of the AD curve (for example caused by the surge in consumer spending), which takes on the equilibrium level of GDP beyond Y2 Yfc potential GDP. This creates a positive output gap and that is what is believed to be the cause of rising inflationary pressures as described above. Excess demand in product markets and factor markets lead to a rise in production costs and this leads to a turning inward in the short term of the overall width of the SRAS1 SRAS2. Low supply of the economy takes a back towards potential output, but at the level of the highest price).

So it may help to explain this idea, the Phillips curve. We can use both diagram SRAS curve is used to prove the non-linear argument. The following chart shows the original Phillips curve in the short term, the trade-off between unemployment and inflation:

The NAIRU

Feet Milton Friedman, who has criticized the foundation for the original Phillips curve in a speech to the American Economic Association in 1968, the concept of NAIRU. It evolved more economists in the United States and United Kingdom. Leading figures developing the concept of NAIRU in the United Kingdom include Sir Richard Layard, Professor Stephen Nickell in the London Stock Exchange. Nickel is now a member of the Monetary Policy Committee to participate in setting interest rates.

NAIRU is defined as the rate of unemployment at the rate of wage inflation is stable.

NAIRU and assumes that there is full competition in the labor market, where some workers have collective bargaining through membership of trade unions with employers. Some employers have a degree of monopsony power when buying inputs work.

According to the supporters of the concept of NAIRU, and the equilibrium level of unemployment is the result of a bargaining process between firms and workers. In this model, workers have in their minds the real wage target. Affected by this wage real targeted through what is happening to unemployment - is supposed to lower the unemployment rate and rising wage demands of the workers will be. Will seek to compromise the staff share the high level of profits when the economy has increased the patrol.

Or not work can meet the real purpose of the payment of wages during the negotiations depends in part on what happens to labor productivity, and also on the ability of business to apply the mark-up on the cost of the product in markets where they operate. Markets in the highly competitive, with many competing suppliers, one would expect less mark-ups (ie, low profit margins) because of competition in the market. In markets dominated by monopoly suppliers, the sign-up on cost is usually much higher, and likely that there will be increasing the share of the surplus product "that the workers may choose to bargain for.

If the actual unemployment rate falls below NAIRU, the theory suggests that the balance of power in the labor market tends to shift to employees rather than employers. The result could be that the economy experiences acceleration in pay settlements and average income growth. Will Ceteris paribus, an increase in wage inflation causes a rise in the cost of paying inflationary pressures. :

The expectations-augmented Phillips Curve

Phillips curve was the original idea to heavy criticism from the school, including cash from the U.S. economic Milton Friedman. Friedman accepted that the short-term Phillips curve exists - but in the long run, the Phillips curve was vertical and there is no trade-off between unemployment and inflation.

He argued that the Phillips curve has both short-term rate expected given the assumption of inflation. If so, there was an increase in inflation caused by the large monetary expansion, and this had the effect of driving inflation expectations higher, it causes an upward shift in the short-run Phillips curve.

Monetary point of view is that AD is trying to promote faster growth and lower unemployment have only a temporary impact on jobs. Friedman says the government can not pay the permanent unemployment below the NAIRU - the result will be higher inflation, which in turn will eventually return to high rates of unemployment, but with the increase in inflation expectations along the way.

Friedman introduced the idea of ​​adaptive expectations - if people see and experience the high rate of inflation in their everyday lives, and they come to expect a higher average rate of inflation in the periods ahead. They may (or trade unions who represent them) and then integrate these changing expectations in the bargain salaries. Wage rates often follow. A wave of inflation in the prices of claims trigger higher wages and higher labor costs and higher prices at the end of the day for goods and services we need and want to buy.

This is evident in the following graph - the highest inflation expectations SPRC2. The result may be what is required to maintain high rates of unemployment at the level of a specific inflation target.

Phillips curve to raise expectations - argues that attempts by government to reduce unemployment below the natural rate of unemployment by increasing aggregate demand will be a great success in the long term. The effect is merely to provide the highest rates of inflation and with it an increase in inflation expectations. School believes that the best monetary and controls inflation by imposing severe restrictions on money and credit. Can be a credible policy to maintain the highest inflation, as in the positive impact of lowering expectations of inflation - caused a shift downward in the Phillips curve. .

The long run Phillips Curve

Attention is also usually a long-term Phillips curve is vertical - but long-term curve can be turned inward with time. .

Have brought home to a shift in the long-run Phillips curve for supply-side improvements in the economy - in particular the decline in the natural rate of unemployment. For example, labor market reforms may be successful in reducing frictional and structural unemployment - because of improved incentives to find work or gain in human capital of the labor force that works to improve the occupational mobility of labor maybe.

What has happened to the inflation-unemployment trade off for the UK?

The disappearing Phillips Curve

Conventional economic wisdom suggests that real GDP is high growth and low unemployment rate will lead to high rates of inflation, moreover, that any attempt to contract activity level of long-term sustainable indefinitely is likely to lead to accelerating inflation. However, over the past decade, inflation has been both quiet and stable, while the unemployment rate has fallen. Any positive relationship between economic activity and inflation has disappeared. .

The proof is that the supposed trade-off in the UK has improved over the past ten to fifteen years. In fact since the early 1990s, Britain has enjoyed a long period of low unemployment and stable, inflation low. The following table provides some data supporting this view .. .

Factors that might explain the improved trade-off

No one factor is in itself sufficient to explain the change (or improve) trade-off. And highlights some of the key are explained below:

The flexibility of the UK labour market

And increased labor market more flexible in the size of the labor supply and reduce the power of trade unions and collective bargaining power cut for many workers. Low long-term unemployment is a sign of a decline in the rates of structural unemployment. We can be pretty certain that the NAIRU (non-accelerating inflation rate of unemployment) may come down. Although the NAIRU is not something that we can monitor and measure directly, and estimated that the NAIRU has fallen from about 10% of the workforce in 1992 to about 5% in the past few years.

Benefits of immigration

Although the precise effects of the economic impact of labor migration is very difficult to determine with any degree of accuracy, and a rise in the volume of migration to the interior, from the EU accession of ten countries and elsewhere, have helped to ease labor shortages in some sectors of the economy, and thus help control the upward pressure on wage inflation ..

The effect of credible inflation targets

The use of inflation targets, which were introduced in1992 to reduce inflation expectations. For Britain, it has been the adoption of inflation targets is an important step in establishing the credibility of the monetary policy framework as a way for "embedding" of low inflation in the British economy. ..

Low inflation in the global economy

External economic factors are very important! For ten years or more, and cost and price inflation in many parts of the world economy on a downward path. Has already been the buzz word risk of deflation in many developed countries. And more rapid progress in globalization, the intensity of competition between states and the low prices of many imported products. The pricing power of manufacturing firms in a large number of global markets is greatly reduced by the pressures of globalization. It has become much harder to make the high prices, "the stick" when there is a lot of competing suppliers in different countries.

Technological change and innovation

Has raised labor productivity and reduce production costs across many different industries. It was such a fundamental change in the supply side of the British economy and international key factor keeping inflation low even if the decline in unemployment.

Increased competition in domestic and international markets

The British economy is affected significantly by the process of deregulation in many local markets and increasing competitive pressures that come from the globalization of world economy. There is strong evidence that shifts in comparative advantage may have worked in our favor in recent years. According to research from the Bank of England, and the conditions of international trade - and this is the price of goods and services we export relative to the price of this import - moved to Britain. This means that if the income of people at work were not only to rise in line with the price of production in the United Kingdom, and the purchasing power of workers in the UK - who buy imported goods, as well as goods produced here - and despite the rise. This in turn reduced the pressure for higher wages. This is known to influence the real wage of the product. Cheaper and imports to increase real purchasing power of wages earned by people who live and work in the United Kingdom .. 

Why does a change in the Phillips Curve / NAIRU matter?

Our focus here is the potential effects of this process of government policy in the macroeconomy. ..

Setting interest rates:

First you will have a decline in the NAIRU to determine the effects of short-term rates by the Monetary Policy Committee. If they think that the labor market can operate with a lower unemployment rate without the risk of the economy recorded a big rise in the rate of inflation, and may then be prepared for the Bank of England to run monetary policy with low interest rate for a longer period. This has knock-on effects for the growth of aggregate demand and lower interest rates work their way through the mechanism of transmission.

Forecasts for economic growth:

Second, trade-off between unemployment and inflation affect the expectations for how quickly the economy can grow comfortably in the medium term. This information is vital for the government when deciding on key decisions in fiscal policy. For example, how much they can afford to spend on key public services, education, transport, health and defense. Growth expectations affect the expected revenues from taxes, which together with the plans of government spending and then determine how much the government may have to borrow (the budget deficit) ..

Key Points

The possibility of short-term trade-off between unemployment and inflation continues to exist! If allowed aggregate demand to the GDP economy grow well above potential, then unemployment will fall, but there is a risk of rising inflation
    1- Changes in inflation expectations change from a position of short-term Phillips curve in the space of X, Y axis - a decline in inflation expectations lead to a downward shift of the SRPC
    2- Monetary policy is probably the most influential in influencing inflation expectations - the success of the Bank of England since 1997 have affected the trade, unemployment and inflation out of the United Kingdom. Low global inflation rates have also had the effect of reduced inflation expectations.
    3- Can supply-side policies that increase productivity and output are likely to help the cause of turning inward in the long-term Phillips curve
    4- There was a decline in the NAIRU in the United Kingdom over the past fifteen years due to the decline in the unemployment rate from the balance
     5-Most estimates, the United Kingdom NAIRU has less than most countries within the twelve single currency (the euro zone). And the NAIRU is probably about 5% of the workforce
     Although unemployment has remained low, and kept on some external factors inflationary pressures in check (including the strong exchange rate and lower commodity prices)