Unemploymen and Phillips curve
2 of The Naural Rae of Unemploymen and he Phillips Curve Figure 1 Inflaion versus Unemploymen in he Unied Saes, 1900 o 1960 During he period 1900 o 1960 in he Unied Saes, a low unemploymen rae was ypically associaed wih a high inflaion rae, and a high unemploymen rae was ypically associaed wih a low or negaive inflaion rae. The Phillips curve, based on he daa above, shows a negaive relaion beween inflaion and unemploymen.
3 of Inflaion, Expeced Inflaion and Unemploymen e P P ( 1 ) F( u, z) The above equaion is he aggregae supply relaion derived in Chaper 7. This relaion can be rewrien o esablish a relaion beween inflaion, expeced inflaion, and he unemploymen rae. Firs, he funcion F, assumes he form: F( u, z) 1 u z Then, replace his funcion in he one above: P P e 1 1 ( )( u+ z)
4 of Inflaion, Expeced Inflaion and Unemploymen e P P ( 1 ) F( u, z) The appendix o his chaper shows how o go from he equaion above o he relaion beween inflaion, expeced inflaion, and he unemploymen rae below: e ( z) u
5 of Inflaion, Expeced Inflaion and Unemploymen According o his equaion: e ( z) u An increase in he expeced inflaion, e, leads o an increase in inflaion,. Given expeced inflaion e, an increase in he markup,, or an increase in he facors ha affec wage deerminaion, z, lead o an increase in inflaion. Given expeced inflaion, e, an increase in he unemploymen rae, u, leads o a decrease in inflaion,.
6 of Inflaion, Expeced Inflaion and Unemploymen e ( z) u When referring o inflaion, expeced inflaion, or unemploymen in a specific year, he equaion above needs o include ime indexes, as follows: e z u The variables, e, and u refer o inflaion, expeced inflaion and unemploymen in year. and z are assumed consan and don have ime indexes.
The Phillips Curve 7 of The Early Incarnaion If we se e = 0, hen: ( z) u This is he negaive relaion beween unemploymen and inflaion ha Phillips found for he Unied Kingdom, and Solow and Samuelson found for he Unied Saes (or he original Phillips curve).
The Phillips Curve 8 of The Early Incarnaion The wage-price spiral: Given Pe =P-1: u W P P P P 1 1 Low unemploymen leads o a higher nominal wage. In response o he higher nominal wage, firms increase heir prices and he price level increases. In response, workers ask for a higher wage. Higher nominal wage leads firms o furher increase prices. As a resul, he price level increases furher. This furher increases wages asked for by workers. And so he race beween prices and wages resuls in seady wage and price inflaion.
The Phillips Curve 9 of Muaions Figure 2 Inflaion versus Unemploymen in he Unied Saes, 1948 o 1969 The seady decline in he U.S. unemploymen rae hroughou he 1960s was associaed wih a seady increase in he inflaion rae.
The Phillips Curve 10 of Muaions Figure 3 Inflaion versus Unemploymen in he Unied Saes Since 1970 Beginning in 1970, he relaion beween he unemploymen rae and he inflaion rae disappeared in he Unied Saes.
The Phillips Curve 11 of Muaions The negaive relaion beween unemploymen and inflaion held hroughou he 1960s, bu i vanished afer ha, for wo reasons: An increase in he price of oil, bu more imporanly, Change in he way wage seers formed expecaions due o a change in he behavior of he rae of inflaion. The inflaion rae became consisenly posiive, and Inflaion became more persisen.
The Phillips Curve 12 of Muaions Figure 4 U.S. Inflaion since 1900 Since he 1960s, he U.S. inflaion rae has been consisenly posiive. Inflaion has also become more persisen: A high inflaion rae his year is more likely o be followed by a high inflaion rae nex year.
The Phillips Curve 13 of Muaions Suppose expecaions of inflaion are formed according o e 1 The parameer capures he effec of las year s inflaion rae, -1, on his year s expeced inflaion rae, e. The value of seadily increased in he 1970s, from zero o one.
The Phillips Curve 14 of Muaions We can hink of wha happened in he 1970 s as an increase in he value of over ime: As long as inflaion was low and no very persisen, i was reasonable for workers and firms o ignore pas inflaion and o assume ha he price level his year would be roughly he same as he price level las year. Bu, as inflaion became more persisen, workers and firms sared changing he ways hey formed expecaions.
The Phillips Curve 15 of Muaions e 1 z au When equals zero, we ge he original Phillips curve, a relaion beween he inflaion rae and he unemploymen rae: ( z) u When is posiive, he inflaion rae depends on boh he unemploymen rae and las year s inflaion rae: 1 ( z) u
The Phillips Curve 16 of Muaions When θ equals 1, he relaion becomes (moving las year s inflaion rae o he lef side of he equaion) 1 ( z) u When =1, he unemploymen rae affecs no he inflaion rae, bu he change in he inflaion rae. Since 1970, a clear negaive relaion emerged beween he unemploymen rae and he change in he inflaion rae.
The Phillips Curve 17 of Muaions Figure 5 Change in Inflaion Versus Unemploymen in he Unied Saes Since 1970 Since 1970, here has been a negaive relaion beween he unemploymen rae and he change in he inflaion rae in he Unied Saes. 4.4% 1 0.73u The line ha bes fis he scaer of poins for he period 1970-2006 is:
The Phillips Curve 18 of Muaions The original Phillips curve is: ( z) u The modified Phillips curve, or he expecaions-augmened Phillips curve, or he acceleraionis Phillips curve, is: 1 ( z) u
The Phillips Curve 19 of Back o he Naural Rae of Unemploymen Friedman and Phelps quesioned he rade-off beween unemploymen and inflaion. They argued ha he unemploymen rae could no be susained below a cerain level, a level hey called he naural rae of unemploymen. The naural rae of unemploymen is he unemploymen rae such ha he acual inflaion rae is equal o he expeced inflaion rae. 0 ( z) u n u n hen, z
The Phillips Curve 20 of Back o he Naural Rae of Unemploymen Then, e au e z a a u u n Finally, assuming ha e is well approximaed by -1, hen: 1 ( u u ) n This is an imporan relaion because i gives anoher way of hinking abou he Phillips curve in erms of he acual and he naural unemploymen raes, and he change in he inflaion rae.
The Phillips Curve I also gives us anoher way of hinking abou he naural rae of unemploymen. The non-acceleraing-inflaion rae of unemploymen, (or NAIRU), is he rae of unemploymen required o keep he inflaion rae consan. 21 of Back o he Naural Rae of Unemploymen 1 ( u u ) n The equaion above is an imporan relaion for wo reasons: I gives us anoher way of hinking abou he Phillips curve: as a relaion beween he acual unemploymen rae u, he naural unemploymen rae u n, and he change in he inflaion 1 rae
A Summary and Many Warnings 22 of Le s summarize wha we have learned so far: The aggregae supply relaion is well capured in he Unied Saes oday by a relaion beween he change in he inflaion rae and he deviaion of he unemploymen rae from he naural rae of unemploymen. When he unemploymen rae exceeds he naural rae of unemploymen, he inflaion rae decreases. When he unemploymen rae is below he naural rae of unemploymen, he inflaion rae increases.
23 of Theory ahead of Facs: Milon Friedman and Edmund Phelps Economiss are usually no very good a predicing major changes before hey happen. Here is an excepion. In he lae 1960s precisely as he original Phillips curve relaion was working like a charm wo economiss, Milon Friedman and Edmund Phelps, argued ha he appearance of a rade-off beween inflaion and unemploymen was an illusion. Friedman could no have been more righ. A few years laer, he original Phillips curve sared o disappear, in exacly he way Friedman had prediced.
A Summary and Many Warnings 24 of Variaions in he Naural Rae Across Counries u n z The facors ha affec he naural rae of unemploymen above differ across counries. Therefore, here is no reason o expec all counries o have he same naural rae of unemploymen.
A Summary and Many Warnings 25 of Variaions in he Naural Rae Over Time 1 ( z) u In he equaion above, he erms and z may no be consan bu, in fac, vary over ime, leading o changes in he naural rae of unemploymen. The U.S. naural rae of unemploymen has decreased o a level beween 4% and 5% oday.
26 of Wha Explains European Unemploymen? Figure 1 Unemploymen Raes in 15 European Counries, 2006
27 of Has he U.S. Naural Rae of Unemploymen Fallen since he Early 1990s and, If So, Why? Figure 1 Change in Inflaion versus Unemploymen in he Unied Saes since 1997
28 of Has he U.S. Naural Rae of Unemploymen Fallen since he Early 1990s and, If So, Why? Par of he decrease, however, seems aribuable o oher facors. Among hem: The aging of he U.S. populaion. The increase in he prison populaion. The increase in he number of workers on disabiliy. The increase in emporary help employmen. The unexpecedly high rae of produciviy growh since he end of he 1990s.
A Summary and Many Warnings 29 of High Inflaion and he Phillips Curve Relaion The relaion beween unemploymen and inflaion is likely o change wih he level and he persisence of inflaion. When inflaion is high, i is also more variable. The form of wage agreemens also changes wih he level of inflaion. Wage indexaion, a rule ha auomaically increases wages in line wih inflaion, becomes more prevalen when inflaion is high.
A Summary and Many Warnings 30 of High Inflaion and he Phillips Curve Relaion Le denoe he proporion of labor conracs ha is indexed, and (1 ) he proporion ha is no indexed. Then: ( u u ) e n [ ( 1 ) ] ( u u ) e n The proporion of conracs ha is indexed responds o, while he proporion ha is no responds o e. When =0, all wages are se on he basis of expeced inflaion (equal o las year s inflaion), hen: 1 ( u un )
A Summary and Many Warnings 31 of High Inflaion and he Phillips Curve Relaion When is posiive, u u ( 1 ) ( ) 1 n According o his equaion, he higher he proporion of wage conracs ha is indexed he higher --he larger he effec of he unemploymen rae on he change in inflaion. When is closer o 1, small changes in unemploymen can lead o very large changes in inflaion.
A Summary and Many Warnings 32 of Deflaion and he Phillips Curve Relaion Given he very high rae of unemploymen during he Grea Depression, we would have expeced a large rae of deflaion, bu deflaion was limied and inflaion was acually posiive. The reason for his may be ha he Phillips curve relaion may disappear or a leas become weaker when he economy is close o zero inflaion.
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