1. Wither the Phillips Curve?
Activist demand management or
Laissez – faire ?

2. Phillips Curve: Demand Side Inflation – Unemployment Tradeoff
A.W. Phillips (1958): found wages rose with falling unemployment in UK
an inverse relation between wage inflation and unemployment.
Paul Samuelson and Robert Solow: an inverse relation between CPI inflation and unemployment in the US.
A downward-sloping “Phillips Curve”  a policy trade-off between inflation and unemployment.

3. Phillips Curve, United States, 1961–1969

4. United States 1955–2000
The relationship broke down when policymakers tried to apply it  no evidence of a long-run Phillips Curve.

5. A Shifting Phillips Curve?
How to reconcile the long-run data with the Phillips Curve trade-off:
Treat the long-run as a series of short-run curves.

6. Aggregate Demand and Supply  Phillips Curve

7. Expectations and the Phillips Curve
Starting at (1): 5% unemployment and 3% inflation. People believe inflation will continue at 3%  Curve I.
Then Fed hypes inflation to 6%  unemployment falls to 3% (Point 2 on Curve I).
Expectations adjust to 6% inflation  Wage demands up  Economy moves to point (3) Unemployment returns to 5%.
If expectations adjust instantly, e.g., anticipating Fed’s policy, economy moves directly from (1) to (3).

8. How the Phillips Curve Works: Inflation, Wages, and Unemployment, (unchanged expectations)

9. How the Phillips Curve Works: Inflation, Unemployment, and Wage Contracts (unchanged expectations)

10. Expectations Formation
Adaptive Expectations: expectations of the future based on history
The public acts on its expectations
The present depends on the past

11. Expectations Formation
Rational Expectations: expectation based on all available relevant information.
The public understands how the economy works.
The public knows the structure and linkages between variables in the economy.
The public anticipates policy actions and their consequence
The public acts now on its expectations
The present depends on the future

12. Inflation & Expectations
:  t – t-1 = 6.5% – 1.0ut