A Kind of Neither Keynesian Nor Neoclassical Model (4): The Nature of Philips Curve

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1 Open Access Libay Jounal 2017, Volume 4, e3388 ISSN Online: ISSN Pint: A Kind of Neithe Keynesian No Neoclassical Model (4): The Natue of Philips Cuve Zhan Zhan 1, Mingan Zhan 2 1 Westa College, Southwest nivesity, Chongqing, China 2 Yunnan nivesity, Kunming, China How to cite this pape: Zhan, Z. and Zhan, M.G. (2017) A Kind of Neithe Keynesian No Neoclassical Model (4): The Natue of Philips Cuve. Open Access Libay Jounal, 4: e Received: Januay 19, 2017 Accepted: Mach 11, 2017 Published: Mach 14, 2017 Copyight 2017 by authos and Open Access Libay Inc. This wok is licensed unde the Ceative Commons Attibution Intenational License (CC BY 4.0). Open Access Abstact Officials always want to use the eplacement elationship between the unemployment ate and the pice of the Phillips cuve to educe the unemployment ate, but things go cisscoss. The eason is that thee is no causal elationship between pice and unemployment. In this pape, it demonstates the Phillips cuve is deived fom the unemployment cycle equation and the inflation equation. And then, it discusses the influence of coe vaiables and fluctuating vaiables on Phillips cuve and the cause of distotion o complete disappeaance of Phillips cuve. Finally, this pape discusses monetay neutality and elated monetay policy issues. The policy that is conducive to the smooth opeation of the system is consistent with the constant money supply of the economic cycle, athe than counte-cyclical egulation. Subject Aeas Economics Keywods Philips Cuve, Inflation, nemployment Rate, Monetay Neutal 1. Intoduction Although it is vey difficult to identify the cause-and-effect elationship between vaiables, thee ae many connections between vaiables in economics. Phillips cuve tells us: statistical data of the nited Kingdom duing show thee is specific substitutional elation between the change ate of nominal wage and unemployment ate [1]. This elation can be explained by the aggegate demand and supply: when the demand cuve shift towad left, the equilibium pice, the equilibium output and employment ate deceases (the unemployment ate inceases), the unemployment ate and inflation ate ae evese DOI: /oalib Mach 14, 2017

2 changes. In this case, both theoetical explanation and statistical data, why does the govenment not use fiscal policy o monetay policy to incease aggegate demand and educe the unemployment ate? Howeve, the pactice in the nited States and Euope in the 1970s shows that the esult of this policy has led to highe unemployment. In ode to explain this phenomenon, people have built some new ideas, such as inflation expectations, adaptive expectations, etc. [2] [3] [4]. nfotunately, thee ae vey few people to doubt about the eality of the causal elationship between the unemployment and pice in Phillips cuve. 2. The Dominant Phillips Cuve In the pape A Kind of Neithe Keynesian No Neoclassical Model (2): The Business Cycle [5], we deive the employment cycle equation fom the Cobb- Douglas function: R E = ( 1 α β) + N. It shows that: 1) When the change ate of the labo population N is constant, the change ate of employment ate R E ae detemined mainly by the eal inteest ate. 2) Accoding to the phase diagam ~ R E, we know that the peiodicity of R E is detemined by the peiodicity of. Figue 1(a) is the theoetical elationship between the phase diagams ~ R E and ~, and Figue 1(b) and Figue 1(c) ae thei time path diagams. Fom the phase diagam RE ~ R E in Figue 1(d), we can futhe daw the time path of the employment ate R E, as shown in Figue 1(e). 3) Fom the elationship between the unemployment ate and the employment ate R = 1 RE, we can see that the size and peiod of R ae also detemined by. Figue 1(e) vetical flip, we get Figue 1(f) shows the time path of unemployment ate R. Fom the inflation equation P θ P = M Y [6], we can see that the inflation ate P is affected by two factos: the ate of change of money M and the ate of change of output Y. Fom the equation of output cycle Y = +, we know that the change ate of nominal output is detemined by and its change ate. Although the elationship between Y and is moe complex than Y and, unde cetain conditions, thee is also a eal vaiable equation Y = +, which is simila to the nominal vaiable equation Y = +. Theefoe, P is also affected by the eal inteest ate, except fo the effect of M. Since the cycle of M is also detemined by the phase diagam ~ M, the cycle of P is also detemined by. Figues 1(g)-(j) shows biefly the theoetical pocess. Finally, since the employment ate R E and the inflation ate P ae in the same diection as the fluctuation of, the fluctuation of the unemployment ate R is opposite to the employment ate R E, as shown in Figue 1(f). Figue 1(f) and Figue 1(h) show the esults of the theoetical deivation: the wave diection of R is opposite to P. Figue 2 is the statistical data of the inflation ate P and the unemployment ate R duing in the nited States. In the thee peiods of , and P and R ae in accodance with the OALib Jounal 2/14

3 theoetical assumptions of Figue 1. If R and P fo the coodinates of dawing with thee peiods of data, the tend line of the scatte diagam is the OALib Jounal 3/14

4 Phillips cuve of the negative slope, as shown in Figue 3. Looking at the thee Phillips cuves, we will not be as supised when A. W. Phillips was at that time. Since we know fom the peiodic and inflation equations that the decline in R is not caused by an incease in P but by. In othe wods, in the Phillips cuve, R and P ae not causal elations, but they ae affected by the same facto and have a coelation. A futhe poblem is that only thee cycles of R and P has Phillips cuve chaacteistics in the nine cycles duing The vaiables R, P and ae decomposed into coe vaiables and fluctuating vaiables, R = R + R, P = P + P and = +, which may help us explain why the Phillips cuve disappeas. It can be seen fom Figue 2 that the Phillips cuve appeas at a time when the coe vaiable P is not vey high o vey low, and the fluctuating vaiable P is not suppessed. This is because R is also stable when P is elatively stable, and the change of R is mainly eflected in the peiodic vaiation of R. When P vaies widely, P may in tun affect, OALib Jounal 4/14

5 and the standad fom of the Phillips cuve will be distoted, o even completely disappea. 3. The Recessive Phillips Cuve If the highe coe inflation ate P poduces inflation cost, the maket efficiency and the coe eal inteest ate will educed, and then will move to the left in Figue 1(a), the coe employment ate R E will also move to the left in Figue 1(d). Coespondingly, and R E in Figue 1(b) and Figue 1(c) will otate clockwise and otate R in Figue 1(f) counteclockwise. If the highe inflation is managed, R in Figue 1(f) will otate clockwise. Figue 4(a) and Figue 4(b) show espectively the foms of P and R when P and R otate clockwise and counteclockwise. Figue 4(c) shows the change foms of P and R when P is gadually deceased at the high level. It is shown that the fluctuation vaiables P and R fluctuate unde the influence of when the coe vaiables P and R change, but ae often obscued by the changes of the coe vaiables P and R, especially when the vaiation of P and R is lage. In Figue 2, the elationship between P and R is not chaacteistic of Phillips cuve duing , and the scatte diagam ae shown in Figue 5(a), and the slope of Phillips cuve is not negative. Howeve, if the change path of P OALib Jounal 5/14

6 and R in the peiod of is cut off as shown in Figue 5(b), it will be vey simila to the pediction of Figue 4(c). In the cycle duing , P and R still have the chaacteistics of the evese fluctuations, but because P and R change in a lage ange to cove the changes of P and R, so that P and R become the ecessive Phillips cuve. This shows that the evesal of the elationship between R and P, which was discoveed by A. W. Phillips in 1958, is an invese change of P and R in the business cycle. The change of P and R may obscue the change of P and R when the changes of P and R ae lage, so that the evese change between R and P disappeas. Although the dominant Phillips cuve will disappea when the change of P and R is lage, the Recessive Phillips cuve still exists in most cases, because P and R ae still in the opposite diection. This can be used to filte out the tend changes in R and P, by means of diffeential methods and to keep the fluctuations in R and P, that is, to obseve the fluctuations of R and P. As shown in Figue 6, in the nine cycles fom 1970 to 2015, except fo two cycles of and , the fluctuation diections of R and P ae obviously opposite. This indicates that the vaiation of R and P in these seven cycles is not the dominant o ecessive Phillips cuve. In the 1970s, as Hebet Stein said, It was a messy time. when Pesident Richad Nixon was in powe [7]. Although R and P ae still affected by, the apid ise of P leads diectly to the decease of, so befoe 1976, R and P ae apidly inceased by P and R Kidnapping, the stagflation has become the economic chaacteistics of the time. In highe inflation, the cyclical OALib Jounal 6/14

7 elationship between P and othe vaiables may disappea. Especially in the case of hypeinflation, the change of P is small enough to be negligible compaed to the lage change of P. The 1990s wee times when Fedeal Reseve Chaiman Alan Geenspan used monetay policy to fine-tune the discount ate, inflation, and unemployment. It can be seen fom Figue 2 that in the peiod of , the fluctuation of R and P is almost completely contolled, and the decline of R is moe obvious than P. This, on the othe hand, distots the standad Phillips cuve: inflation and unemployment may both ise and decline in the same diection, and the latte change is the ideal state in which people deam. Howeve, this attempt to eliminate the pecise contol of the Phillips cuve became the impotant cause of the subsequent financial tsunami. The above analysis shows that the vaiation of the coe vaiables P and is distinguished fom the vaiation of the fluctuation vaiables P and to explain moe clealy why P and R ae sometimes evese-changing and sometimes changing in the same diection. Whethe the dominant o ecessive Phillips cuve, fom the pevious analysis can be dawn the following conclusions: 1) The elationship between P and R in the Phillips cuve is not causal. 2) The fluctuation of is the common cause of the fluctuations of P and R. 3) When the vaiation ange of P is lage, the change of P will not only obscue the change of P, but also cause to decease, though it will not occu in the cuent peiod. 4) The dominant Phillips cuve appeas at the time when P is elatively stable and P is not suppessed. 4. Conditions of Monetay Neutality The analysis of the implicit Phillips cuve gives us a deep undestanding of the OALib Jounal 7/14

8 elationship between inflation and unemployment, but it still fails to answe the most impotant pactical poblem in monetay eseach: Is money only affecting pices, o both pice and eal output? O unde what cicumstances money is neutal and what is non-neutal. Fom the simplest quantity equation am = PY, to the quantity equation P θ P = M Y which eflects the cyclicality of money, we still cannot answe this question. Even if the S dolla against the Japanese Yen dops fom 1 SD/120 JPY to 1 SD/1 JPY, only the exchange coefficient a in the quantity equation am = PY needs to be adjusted, it s still not clea what effects that M will put on Y. Since Y is detemined by the Cobb-Douglas function and not by the money-quantity equation, ou macoeconomic vaiable equation cannot answe this question. This is a micoeconomic poblem. As the cedit cad payment and Intenet payment is not popula in India, the abolition of two cuent banknotes on Novembe 8, 2016 has caused poblems of maket tansactions. Theefoe the intenational cedit ating company loweed the 2016 economic gowth ate of India. In the case of a decline in poduction efficiency due to a shotage of cash, supplementing o inceasing the money supply is cetainly conducive to the ecovey of GDP. But if it was not the case that the lack of banknotes causes the incease of tansaction cost, such as in India, would the incease of money supply bing up the eal output? In addition to the dominant function as a tading media, wealth stoage and measuement of wealth unit, money also has a function of tansfeing wealth that is easily to be neglected. Fo example, the actual wealth of ceditos gadually educed in a cetain monetay policy, o the buden of the debto continues to incease unde a cetain monetay policy. If the expansion of the cental bank balance sheet could aise GDP, it is cetainly not a diect pocess as the incease of savings is the incease of eal wealth in pesonal accounts. It should be the wealth tansfe effect of money supply changes the opeating efficiency of economic systems, and then cause a change in GDP. In the micoeconomic maket, any tansfe o movement of wealth needs to be elated to poduction o sevice, and because the pocess is completed in competition, it is efficient. Does the wealth tansfe effect caused by the incease o decease of money supply is efficient? Fom the pespective of tansfe payments, the ole of monetay and fiscal policies is simila. Fiscal policy is the fomation of tansfe payments between taxpayes and govenments o between diffeent industies by inceasing taxes o bonds. Monetay policy is a tansfe between debtos and ceditos. As a social esponsibility, the govenment sometimes has to do something, but it is not as Keynesian theoy descibes that govenment spending will have a multiplie effect. The most exteme case of fiscal policy is that when the national tax o debt is not sufficient to maintain the liquidity of finance, the spending of govenment can only ely patly o entiely on the incease issuance of money. This appeas to be a fiscal act, but essentially it is a monetay policy abducted by fiscal policy. It has a geate impact on the opeational efficiency of the system OALib Jounal 8/14

9 than fiscal o monetay policy alone, since these Seignioage may have no connection with poduction and sevices. The downside of inflation is not the negligible tansaction costs such as shoe-leathe cost o menu cost, but the inefficient o low-efficient poduction caused by the incease o decease in wealth that does not coespond to poduction o sevices. On the one hand, companies with highe poduction costs o poo maket demand may not be eliminated because of the debt buden unde inflation. On the othe hand, duing the deflation, the money saves can gain the ewads of wealth without competition unde deflation. Theefoe, though we cannot find the effect of M on Y in the equation P θ P = M Y, the wealth tansfe effect caused by the change of money supply would affect Y by changing P. Y is decided by its maginal state, and since is moe sensitive than Y in eacting to M, we choose to obseve the vaiation tend of M and in statistical data. Figue 7 shows that duing the peiod of stagflation in , M inceased, deceased and the value was negative in It indicates that the expansion of the cuency seveely damaged the opeating efficiency of the system. Duing , the declining tend of M and the self-epai capacity of maket led to a shap ise in, and then stabilized at a high level of aound The highly paised Reagan economy actually should cedit Pesident Cate s contol of inflation and fiscal spending that began in the late 1970s [7]. began to decline in 2001, and in its value was less than 0. The eason is due to the impact of low M duing , and moe impotantly, the inteest ate dependent syndome (IRDS) fo inteest ate contols ceated by Fedeal Reseve Chaiman Alan Geenspan and his successo. The financial cisis in 2008, in fact, is the esult of the economic system adjusted itself since it could not bea with people always benefitted though the housing finance unde OALib Jounal 9/14

10 the low inteest ate policy. Theefoe, accoding to the statistics of M and, the effect of vaying money on the cental bank s balance sheet is not neutal. In the field of micoeconomics, the occasional tansfe of wealth (such as donations of heitage) that does not coespond to the poduction o sevices has limited effects on the efficiency of the entie economic system. Howeve, inflation o deflation in the macoeconomics field will have a negligible impact on the system. The non-neutality of money is not only eflected in the effect of tansfe payments, but also on the consistency of the elationship between the actual vaiables and the nominal vaiables, that is, the coodination effect of money. Befoe the appeaance of peiodic equation Y = +, we can diectly convet actual values by the definition between actual values and nominal values. Fo example: the actual output and nominal output can be conveted accoding to the equation Y = Y P o Y = Y P ; the basic equation of nominal vaiables Y = Y [8], can be diectly ewitten as the basic equation of actual vaiables Y = Y. Howeve, consideing the peiodic elationship between vaiables, the nominal vaiable cannot be diectly ewitten as the actual vaiables in some equations. Fo example, Y = + cannot be ewitten as Y = +. In geneal, only when P = 0 o P =, thee is no diffeence between the actual vaiables and the nominal vaiables in the macoeconomics system. Fom = + P, d( + P ) d P dp Y = + = + P + = + P + +, + P + P + P P substitute the left side of the above equation with Y = Y + P, then, P Y = + + P + P + P When P = 0, the above equation can be simplified as Y = +. And when P =, since dp d P = P = = then, P Y = + + P = + + = + + P + P + P + This is the eason that the elation of Y and can only be expessed as Y + in ou pevious pape, and the fluctuation of actual vaiables is diffeent fom and even moe volatile than that of nominal vaiables. Since the diffeence of fluctuation between actual and nominal vaiables may lead to moe speculative activities and then lowe the efficiency of maket system opeation. Theefoe the bette the consistency of actual and nominal vaiables, and the close the fluctuation patten is in the time path, the smalle the loss of system opeating efficiency. To study the so-called monetay neutality, we not only need to conside the tansfe payment when pice changes, but also the OALib Jounal 10/14

11 coodination effect between actual and nominal vaiables. It is vey difficult to make P = 0 because of the change of P and P. Theoetically, the cental bank can offset the change in P by contolling o M (as the Fedeal Reseve did in the cycle of ) to achieve this goal. Howeve, since achieving this goal will suppess the natual fluctuation of the system and then cause poblems to the coodination between actual and nominal vaiables, the choice of taking accounts of both sides is to let the inflation ate equal the eal inteest ate, namely P =. Fiedman used to think that the S dolla could gow at a constant ate of 3% - 5% pe yea [1]. Accoding to the aveage value of fom 1970 to 2016, accoding to the coodination effect of P =, M = =. This is within the scope of Fiedman s poposal. If this is done, the aveage of the inflation ate will be P = = This kind of inflation ate that doubles the eal inteest ate should be modeate inflation. Expeience tells us that modeate inflation will not cause damages to economic opeating efficiency. This is because unde stable money supply, the capital maket will develop financial poducts that can educe o even eliminate the effect of tansfe payments. Because of the adaptability and offsetting effects of the capital maket, the effect of monetay changes on appeas to be in tems of cycles, so that even unde the constant cuency ule, seveal cycles of adaptive adjustment ae equied befoe the system appoaches the so-called ideal opeating state. In this state, vaious vaiables will continue to fluctuate, but thei tend line will be close to a hoizontal line, the phase diffeence of fluctuations will be moe consistent with ou theoetical analysis in the peiodic equation. Figue 8 is a schematic view of this ideal state. Monetay policy in taditional macoeconomics has two impotant oles: fist, to ensue the smooth opeation of the economy, and second, to pomote economic gowth. Fluctuations of vaiables fom 1970 to 2015, except the coectional OALib Jounal 11/14

12 monetay policy in Reagan peiod, it is difficult to say that the S Fedeal Reseve s monetay policy has played these two oles. Fo the fist ole, we theoetically have poved that thee is no fluctuation only unde the simple epoduction state that the maginal output equals to 0. The eal smooth opeation is not to smooth the economic cycle, but to make the elationship between vaiables in the fluctuation simple and clea. Countecyclical monetay policy will not only weaken the maket vitality, and even cause economic cisis. The second ole is usually to stimulate the economy with money. If pinting banknotes could make net inceases of eal wealth gow, even it would multiply the inflation ate is also cost-effective, because the cost of pinting banknotes is negligible compaed with manufactuing cas and building houses not to mention in moden technology we can use electonic money without pinting costs. OALib Jounal 12/14

13 The business cycle is one way of keeping the system alive and does not conflict with the micoeconomic mechanisms. Just as fou seasons can pomote plant metabolism: pospeity is the sping of output gowth, but also the hot bed fo inefficient poduces and poduction pojects; only those entepises that ae able to suvive in the winte of ecession will make a eal contibution to the poduction efficiency of the system. Theefoe, the endogenous cyclical fluctuation in the system is not ou enemies, but economics policies that tell us cuency ae actual wealth and use cuency to against the business cycle. 5. Conclusions Fo a fact without suppoting fom theoies, it is difficult to say that this fact is a geneal law; similaly, fo a theoy without appoving fom fact, it is difficult to be sue of this theoy. Accoding to ou theoy of economic cycle and inflation, the fom of Phillips cuve shows in Figue 9. In the Phillips cuve, thee is no causal elationship between the inflation ate and the unemployment ate, and they appea to be linked because they ae all affected by changing eal inteest ate. Fo the question does the state of money only affect the pice o both pice and eal output?, the analysis of this pape shows that the change of money supply would affect both pice and eal output in the shot un, but the effect is nomally negative, since the tansfe payment that is not linked to any poduction and sevice would affect the opeating efficiency of the system. The idealist state of money should be that people could use them to accomplish tempted tade, and the distibution of actual wealth would not be affected by the amount of money change. Refeences [1] Phillips, A.W. (1958) The Relation between nemployment and the Rate of Change of Money Wage Rates in the nited Kingdom, Economica, 25, [2] Fiedman, M. (1968) The Role of Monetay Policy. Ameican Economic Review, 58, [3] Fiedman, M. (1977) Nobel Lectue: Inflation and nemployment. Jounal of Political Economy, 85, [4] Phelps, E. (1967) Phillips Cuves, Expectation, and Optimal Inflation ove Time. Economica, 135, [5] Zhan, M.A. and Zhan, Z. (2016) A Kind of Neithe Keynesian No Neoclassical Model (2): The Business Cycle. Open Access Libay Jounal, 3, e [6] Zhan, M.A. and Zhan, Z. (2017) A Kind of Neithe Keynesian No Neoclassical Model (3): The Inflation Equation. Open Access Libay Jounal, 4, e3333. [7] Hebet, S. (1994) Pesidential Economics: The Making of Economic Policy fom Roosevelt to Clinton. 3d Revised Edition, Ameican Entepise Institute fo Public Policy Reseach, Washington DC. [8] Zhan, M.A. and Zhan, Z. (2016) A Kind of Neithe Keynesian No Neoclassical OALib Jounal 13/14

14 Model (1): The Fundamental Equation. Open Access Libay Jounal, 3, e Submit o ecommend next manuscipt to OALib Jounal and we will povide best sevice fo you: Publication fequency: Monthly 9 subject aeas of science, technology and medicine Fai and igoous pee-eview system Fast publication pocess Aticle pomotion in vaious social netwoking sites (LinkedIn, Facebook, Twitte, etc.) Maximum dissemination of you eseach wok Submit You Pape Online: Click Hee to Submit O Contact sevice@oalib.com OALib Jounal 14/14