Phillips curve Flashcards
(21 cards)
What is the Phillips curve?
An aggregate supply relation between inflation, expected inflation and unemployment
Basic form of Phillips curve
π =πe+(m+z)−αu
What happens when unemployment decreases
Inflation increases, especially if expectations and markups are stable
What does a high alpha mean in Phillips curve?
A stronger response of inflation to changes in unemployment
Wage price spiral
A cycle where low unemployment raises wages,
firms raise prices,
workers demand even higher wages,
pushing inflation upward
What happened to the USA Phillips curve?
- an increase in the price of oil
- Change in the way wage setters formed expectations due to a
change in the behaviour of the rate of inflation. Inflation rate became consistently positive and inflation became persistent.
Mutations of Phillips curve
Suppose expectations are formed according to πet = θπ t−1.
The parameter θ captures the effect of last year’s inflation rate,
on this year’s expectations.
When θ equals zero
We get the original Phillips curve equation
When θ is positive
The inflation rate depends on both the unemployment rate and last year’s inflation rate
When θ = 1
The unemployment rate affects not the inflation rate but the change in inflation rate
Original Phillips curve
πt = (m + z) −αut
Augmented Phillips curve
πt−πt−1 = (m + z)−αut
Natural rate of unemployment
The unemployment rate
such that the actual inflation rate is equal to the expected
inflation rate.
NAIRU (Non-Accelerating Inflation Rate of Unemployment)
The rate of unemployment required to keep the inflation rate constant.
Formula for NAIRU
un = (m + z) / a
What is the medium-run Phillips Curve form?
πt−πt−1 =−α(ut −un)
Why does NAIRU vary across countries?
Labor market policies (e.g., minimum wage, unemployment benefits)
Product market regulation
Mark-up levels
Wage bargaining systems
What is disinflation
Reduction in the rate of inflation.
Often require temporarily higher unemployment
Why is credibility important for disinflation?
If people believe the central bank is serious, expectations adjust quickly, reducing the economic cost.
What is wage indexation?
Wages automatically adjust to inflation.
Weakens the effect of unemployment on inflation
Phillips curve with wage indexation
πt − πt−1 = −α(1−λ)(ut−un)
