About Phillips Curve
The Phillips Curve is an economic concept, and it has been proposed and initiated by A. W. Phillips to state the reasons for inflation and consequent unemployment. It will lead to the inverse and the stable relationship, and the theory claims the kind of insufficient economic growth, which can, in turn, lead to a more developed job structure leading to less unemployment. However, the authentic concept, as proposed by Phillips Curve, has been empirically disapproved due to the happening of stagflation in the years of 1970s. Here you can notice the high levels of both unemployment and inflation, and you are quite into the field, making ways for the experts.
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There are expectations augmented by Phillips Curve, and the concept is more innovative and encouraging of its kind. The curve is there to state the rate and reasons for unemployment and inflation and also talks about the inverse relationship of the same. The high rate of inflation has a connection with the lower rate of unemployment, and it can even be vice versa. Once you get to know what is Phillips Curve is, you can have a better understanding of the rate of inflation.
What is Phillips Curve?
In trying to understand the concept of the Phillips Curve, you get to know about the change in the rate of unemployment within the specific economic setting. There are the expectations augmented Phillips Curve, and it is something that can have a conventional effect in matters of price inflation. It is all about the inverse relationship between inflation and unemployment, and the same is depicted in the kind of downward economic slopping. One can see the concave curve with the rate of inflation shown by the Y-Axis, and you even have the unemployment being depicted by the X-Axis.
In the year 1960, there has been a fiscal stimulus that can help in increasing the aggregate demand and also helps in initiating the favourable effects. In the process, an increase in the amount of labour demand will help augment the pool of unemployment, and there is a subsequent decrease in the workers with the subsequent increase in the company wages. It is perfect to follow the Phillips Curve equation to attract the portion of the talent pool. The corporate cost of the wages can increase in time, and the companies will pass over those costs to most of the customers in the form of prices.
A simple Phillips Curve equation can be represented as -
U = -h (unemployment - u)
\[\Pi = -h \times (u -u_{n})\]
A simple Phillips curve is typically represented with inflation as a function of employment rate and the hypothetical unemployment rate that would exist if inflation existed as zero. The inflation rate is represented by and the employment rate is denoted by ‘u’. The ‘h’ in the Phillips curve is a positive constant that guarantees that the curve slopes downwards. The ‘\[u_{n}\]’ is the natural rate of unemployment that would result if inflation was zero.
The Concept of NARU
There is an increase in the central bank inflation, and it can help in pushing the level of unemployment to the lower level, as depicted in the Phillips curve equation. There can even be an initial shift along the curve, causing an increase in the expectations of the workers. This will help the inflation get adapted to the new environment, and in the longer run, the curve can have an outward shifting, as you get to see in the Phillips curve PPT. However, things have a relation with NARU or the natural rate of unemployment. This can help in representing the normal rate of institutional and frictional unemployment as part of the steady economy.
The concept will become better clear once you start following the Phillips curve diagram. Especially in the stage of stagflation, the workers and most of the consumers can start to have a rational expectation, and once again, this helps increase the rate of inflation, and with this kind of financial awareness, the money based authority will have plans to embark on expanding monetary policy. Based on the details of the Phillips curve PDF, you can have a better idea about the apt monetary policy with all the necessary fiscal inclusions.
The Phillips curve in economics plays a major role in the probable monetary expansion. Several surveys have proved that the presentation of the Phillips Curve has made things clear in the field of finance. Once you check with the PDF and the diagram, you can see the vertical graph that will show you the rise in the graph and make you better aware of the possible economic growth and development. It is the genre where you can put your trading skills and get into depth with the Phillips curve example. This is sure to have the least effect on the reduced rate of unemployment, and this will make the curve acquire the vertical line.
The entire concept of the Phillips curve is an indispensable part of Economics. It is imperative to have at least rudimentary knowledge of the subject to be aware of the several real-life economic phenomena that we experience and observe. Thus, this well-written article has comprehensively explained all the vital concepts related to the Phillips curve in economics.
FAQs on Phillips Curve: Understanding Inflation and Unemployment
1. What is the Phillips Curve and what is the core relationship it describes?
The Phillips Curve is an economic concept that illustrates a historical inverse relationship between the rate of inflation and the rate of unemployment in an economy. In simple terms, it suggests that when unemployment falls, inflation tends to rise, and when unemployment rises, inflation tends to fall. This trade-off is primarily observed in the short run.
2. What is the difference between the Short-Run Phillips Curve (SRPC) and the Long-Run Phillips Curve (LRPC)?
The primary difference lies in the trade-off between inflation and unemployment:
- The Short-Run Phillips Curve (SRPC) is downward-sloping, indicating a direct trade-off. Policymakers can, in the short term, target lower unemployment at the cost of higher inflation.
- The Long-Run Phillips Curve (LRPC) is a vertical line at the Natural Rate of Unemployment (NAIRU). This implies that in the long run, there is no trade-off. Any attempt to keep unemployment below the natural rate will only lead to accelerating inflation without a permanent decrease in unemployment.
3. How do inflationary expectations cause a shift in the Short-Run Phillips Curve?
Inflationary expectations are crucial in shifting the SRPC. When workers and firms anticipate higher inflation in the future, they adjust their behaviour. Workers demand higher wages to protect their real income, and firms raise prices to cover increased labour costs. This leads to a higher rate of inflation for any given level of unemployment, causing the entire Short-Run Phillips Curve to shift upwards or to the right.
4. What is the role of the Natural Rate of Unemployment (NAIRU) in the Phillips Curve model?
The Natural Rate of Unemployment (NAIRU), or the Non-Accelerating Inflation Rate of Unemployment, is the theoretical unemployment level at which inflation remains stable. It represents the unemployment rate consistent with the economy's full potential, including frictional and structural unemployment. In the Phillips Curve model, the Long-Run Phillips Curve is a vertical line at the NAIRU, signifying that this is the lowest unemployment rate an economy can sustain without causing inflation to accelerate.
5. Why did the original Phillips Curve relationship appear to break down during the stagflation of the 1970s?
The original Phillips Curve failed to explain stagflation—the simultaneous occurrence of high inflation and high unemployment in the 1970s. This breakdown happened because:
- Supply Shocks: The oil price shocks by OPEC increased production costs across the economy, leading to higher prices (inflation) and lower output (higher unemployment).
- Changing Expectations: Persistent inflation led people to expect it to continue. This shifted the SRPC outwards, meaning the economy experienced higher inflation at every level of unemployment, contradicting the stable trade-off the original curve proposed.
6. What are the main policy implications of the Phillips Curve for a country's central bank?
The Phillips Curve provides important insights for monetary policy. The SRPC suggests a short-term 'menu' of policy choices between inflation and unemployment. However, the LRPC serves as a critical warning: attempting to use expansionary policy to hold unemployment below its natural rate indefinitely is not sustainable. It will only result in higher and higher inflation. Therefore, central banks must consider inflationary expectations and focus on maintaining price stability to anchor the economy around the NAIRU.
7. How does the concept of an inflationary gap relate to a position on the Short-Run Phillips Curve?
An inflationary gap occurs when an economy's actual output exceeds its potential output, usually due to excessive aggregate demand. This situation corresponds to a point on the Short-Run Phillips Curve where the unemployment rate is below the Natural Rate of Unemployment (NAIRU). At this point, the economy is 'overheating,' which puts upward pressure on wages and prices, resulting in a higher-than-expected rate of inflation.
8. Is the Phillips Curve still a relevant concept in modern economics?
Yes, the Phillips Curve is still relevant, but in its modern, more complex form. The simple, stable trade-off of the 1960s is no longer a reliable guide. Today, economists use an 'expectations-augmented' Phillips Curve that includes variables like inflation expectations, supply shocks, and changes in the labour market. While some argue the curve has 'flattened' (meaning unemployment has less effect on inflation now), it remains a foundational tool for central banks to analyse and forecast inflation.
