Phillips Curve: Understanding the Relationship Between Inflation and Unemployment, Summaries of Macroeconomics

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Macroeconomics

Phillips Curve

unemployment (figure 1).found a stable statistical tradeoff between inflation and For data for the United Kingdom, the engineer Phillips [1]

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Macroeconomics

Figure 1: Inflation and Unemployment 1861-

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Macroeconomics

Breakdown

the United States, it disappeared for later data (figure 2). Although the relationship held somewhat during the 1960’s for

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Macroeconomics

Figure 2: Inflation and Unemployment in the United States

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Macroeconomics

Price-Setting Equation

prices and wages to be set one per cent higher.is neutral, in that one per cent more expected inflation causesreduces profit margins and wage demands. Expected inflationUnemployment reduces inflation, as smaller aggregate demandexpected inflation.(relative) prices and wages in line with unemployment andprice-setting equation. Firms and workers strive to set realinterprets the inflation-augmented Phillips curve as arespond of price to demand and supply, in contrast one Whereas one interprets the traditional Phillips curve as a

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Macroeconomics

Phillips Curve

Expected Inflation

inflation should be correct, so on average If expectations are rational, on average the expectation of

π

π

e .

By (1), therefore on average

u

=

u N

(^). Consequently

u N

deserves

availability of unemployment benefits.such as the efficiency of job placement and the size andaverage. Its value depends on the economic structure, factorsthe name “natural rate of unemployment,” since it prevails on

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Macroeconomics

Shifting Phillips Curve

However as time passes both

π

e

and

u N

may change, and the

the lack of pattern in figure 2.Phillips curve shifts (figures 3 and 4). Such shifts account for

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Macroeconomics

Figure 3: Changing Expected Inflation

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Macroeconomics

Long-Run Phillips Curve

line at the natural rate of unemployment.In figure 5, the “long-run Phillips curve” is therefore a verticalthe natural rate. Inflation can be high or low. On average, in the long run unemployment must average out to

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Macroeconomics

Figure 5: Long-Run Phillips Curve

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