19) the neo-classical phillips curve Flashcards
what were neo-classicals view on the keynesian phillips curve
Neo-classical economists agree that policies to reduce unemployment will lead to inflation, but they further argue that this is pointless as this any change in unemployment will only be temporary.
what is NRU, explain
Unemployment (they argue) is fixed in the long term at its natural rate (NRU- Natural Rate of Unemployment) and changes in employment behave link a pendulum, always reverting to NRU.
how have the neo-classicals adapted the keynesian model?
They believe therefore that the Phillips Curve (PC) effect is always short-term shown below by the Short Run Phillips Curves, SRPC. In the Long Run, the Phillips Curve (LRPC) shows that the unemployment rate will be at NRU whatever the Price Level.
what is money illusion?
thinking you are better off due to higher money wages but real Wages havent changed.
what is the process towards money illusion?
- The government tried to bring unemployment below the NRU to 3%, maybe using expansionary fiscal policy
- As AD increased, more labour is needed. To tempt extra labour into the market, employers offer higher wages. This causes inflation.
- Thinking they will be better off; more workers have entered the labour market. However, the inflation wipes out their gain.
how do you identify money illusion on the neo-classical phillips curve?
is the diagonal changes in the diagram (A to B and C to D).
what are adaptive expectations?
- Both employers and employees realise that nothing has changed so the demand for labour reverts to NRU
how to identify adaptive expectations on a diagram
the horizontal move
what happens after adaptive expectations?
Employment levels revert to NRU- only effect of the policy is that Price Level has increased- inflation!
- The same process would occur if the government tried again… SPC2 would occur. Then SRPC3… etc.
do neo-classical economists believe in expansionary fiscal policy being beneficial?
Neo- Classical economists believe that expansionary fiscal policy will only ever have an ultimately counter-productive/ short term impact on unemployment. NRU exists at NAIRY- the non-accelerating inflation rate of unemployment. Think about what that means…If we are at this level of unemployment, and we remain at this point, inflation won’t accelerate. This doesn’t mean 0% inflation- it just means stable prices e.g. the horizontal axis could be set at 2%. In the UK the LRPC may be located at 3.7% unemployment and 2% inflation
