8. The Phillips curve, the natural rate of unemployment and Inflation

Question 1

Inflation, expected inflation and unemployment

Answer 1

W = P^e F(u,z) and P = (1+m) W => P = (1+m) P^e F(u,z) =>expected price level P^e ↑ => nominal wage ↑ => prices (price levels)↑
Unemployment ↑ => nominal wage ↓ => prices (price levels)↓

We can also replace F(u,z)=1-αu-z where α = strength of the effect of unemployment on the wage.
P=P^e (1+m)(1-αu-z)
Unemployment ↑ => nominal wage ↓
Z ↑ => wage ↑

π =π^e+(m+z)-αu
expected inflation ↑ => actual inflation ↑
m ↑ z↑ => π↑
u ↓ => π↑

Question 2

The Phillips curve and its mutations

Answer 2

Original Phillips curve : increase in Ut => lower inflation
(Modified) Phillips curve : increase in Ut => decrease in inflation

Ut < Un <=> πt > πt-1
Ut > Un <=> πt < πt-1

Question 3

The Phillips curve and the natural rate of unemployment

Answer 3

Un=(m+z)/α
m ↑ z↑ => U↑

πt - πt-1 = -α [Ut - (m+z)/α ] = - -α (Ut - Un)