18) introducing the phillips curve Flashcards
what does the phillips curve link together?
The Phillips Curve establishes a link between 2 of the most important concepts in Macroeconomics- Inflation and Unemployment
how was the link established?
The link, established in the 1950’s by an economist called Phillips, suggests a trade-off. between inflation and unemployment.
what does the trade-off suggest?
The trade-off suggests that you can achieve one objective (either low inflation or low unemployment) but you can’t achieve both together. In other words, if you target low unemployment (full employment), you may achieve this aim but only at the expense of high inflation. If you target low inflation, you may achieve this but at the expense of high unemployment.
The Phillips curve was a central plank of … economics.
Keynesian
which economic school dominated 1945-1980, how does this link to the phillips curve
In the years between 1945 and 1980, Keynesian economic policies dominated the main economies of the developed world (USA/UK/Germany etc). This meant that, depending on the economic position of the day, they would move between prioritising low unemployment or prioritising low inflation.
what did governments accept?
Governments largely accepted that they were stuck in a never-ending boom-bust cycle and that attempts to grow the economy by increasing AD would inevitably lead to inflation. Equally, if inflation became too high to manage the policies needed to reduce it were going to lead to unemployment and short periods of recession. This is clearly illustrated in the Keynesian AS/AD diagrams (figure 2). From AD 1 to AD2, expansionary fiscal policy causes inflation. From AD2 to AD1, deflationary fiscal policy causes unemployment. The only scenario where this does not occur is a deep recession (large NoG), where AD increases from AD3 to AD2 without leading to an increase in the Price level.
why was the phillips curve discredited?
The Phillips curve was basically a line of best fit based on the actual rates of unemployment compared to the actual rates of inflation. It became discredited in the 1970’s. Following a major external shock to the world economy, developed countries began to experience something called STAGFLATION; high rates of inflation at the same time as high rates of unemployment.
