Output, Inflation, and Unemployment Chapter 11

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Presentation transcript:

Output, Inflation, and Unemployment Chapter 11 Prof. Steve Cunningham Intermediate Macroeconomics ECON 219

Original Phillips Curve A. W. Phillips (1958), “The Relation Between Unemployment and the Rate of Change of Money Wage Rates in the United Kingdom, 1861-1957”, Economica. Wage inflation vs. Unemployment New Zealander at London School of Economics Missing Equation of Keynesian economics?

5½ % = zero inflation

5½ %

Phillips’ Conclusions There exists a stable relationship between the variables. The relationship has not substantially changed for over 100 years. Negative, nonlinear correlation. Wages remain stable/stationary ( =0) when unemployment is 5½%.

Conclusions, Continued From the dispersion of the data points, Phillips concluded that there was a countercyclical “loop”: Money wages rise faster as du/dt decreases, Money wages fall slower as du/dt increases Implies an inflationary bias, and is consistent with sticky wage theory. faster slower u

Natural Rate Theory Milton Friedman In the long run, the influence of money is primarily on the price level and other nominal magnitudes. In the long run, real variables, such as real output and employment are determined by real, not monetary, factors. The equilibrium levels of real output and employment that are consistent with the microeconomics of production and the institutions of the society are called the natural rates of output and employment. Short run levels of output and employment may vary from the natural rates as a result of monetary factors, but in the long run, the economy will always return to the natural rates.

Expectations-Augmented Phillips Curve inflation Natural Rate 5 2 4 SRPC(2) 1 3 2 SRPC(1) 1 Unemployment U1 U* SRPC(0)

Another view: Keynesian Perspective AS2 AS1 3 2 1 AD2 AD1

Policy Implications Milton Friedman. “The Role of Monetary Policy,” American Economic Review (March 1968), 1-17. Different Phillips curves exist for different inflation rates Changes in inflation expectations shift the short-run Phillips curve. Any tradeoff from a single change in the money supply is short-run. Any improvement in the economy due to such monetary stimulus is brief at best, and leads to long-run inflation. To achieve a permanent reduction in unemployment via monetary policy would require continuously increasing the money supply, leading to infinite inflation, and the destruction of the economy. (The accelerationist hypothesis.) To change the natural rate of output requires real sector changes.

Natural Rate: More Recent Work Friedman had argued that the natural rate would be related to the actual structural characteristics of the commodity and labor markets. What would affect people getting information and making adjustments to their economic positions (asking for raises, etc.) Modern theory relates these characteristics to those which determine frictional and structural unemployment: Information costs and impediments to job search Training Natural rates are “time-varying” not “fixed and permanent”.