1. Macroeconomic Analysis 2003
Phillips’ Curve and the Natural Rate of Unemployment Hypothesis
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2. Contents
Motivation
Review of Inflation and unemployment rates over time
Phillips Curve
Output GAP: Potential and Actual Output
Wage Price Spiral
Expectation Augmented Phillips curve
Some exercises
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3. Measurement and Analysis of Fluctuations in the Economy
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4. Unemployment and Inflation
Current unemployment rate:
Current Inflation Rates from the Treasury Web page
Headline inflation – RPI (Dec)
2.9%, up from 2.6 % the previous month
Underlying inflation – RPIX (Dec)
2.7%, down from 2.8% the previous month
HICP inflation (Dec)
1.7%, up from 1.6% the previous month
Producer output prices (Jan nsa)
1.6%, up from 1.3% - revised in the previous month
Producer input prices (Jan nsa)
3.6%, up from 2.8% - revised the previous month
Halifax house prices (Jan)
Down 1.5% on Dec and up 22.5% on a year earlier
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6. Beginning of Stagflation
92 recession
Thatcher’ contraction
Beginning of Stagflation
Brown and New Labour
independent MPC
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10. Breakdown of Bretton Woods
Oil price shock
Breakdown of Bretton Woods
Inflation targeting
Independent
central Bank
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11. Average dwelling prices: by type of buyer in the UK
(in thousands £)
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Source: Office of the Deputy Prime Minister

12. Refer www.halifax.co.uk for the current prices
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15.
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17. Premium unleaded petrol1 prices: EU comparison, mid-June 2002 ( Pence per Litter)
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Source: Department of Trade and Industry

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21. Phillips’ Curve
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22. Phillips’ Curve: Unemployment Inflation Trade-Off9
Inflation
rate 5
Policy Menu
2.5 7 6 5 1
Unemployment
Rate, u 2 -2
Deflation
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23. Total Labour Force and Unemployment Rate in the UK in February 2003LD LS
LD0
LF=29.3
LS=LD
27.8
u = 5.1%
26.37
In Millions
Pay rise by modernisation or bargaining?
u=10%
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24. Labour Demand, Labour Supply and UnemploymentLS u w u w LS
LD1
LD2
Labour Demand LF
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25. Higher Wage Rate Translates into Higher Prices
Aggregate Demand, Productive Capacity and the Price Level
Higher Wage Rate Translates into Higher Prices
New Classical AS
Price Level P5 P4 c
AD3 b P3
Keynesian
AD2 P1 a
New Keynesian part
AD1
AD4
AD0 Y3 Yc Y0 Y1
Output Gap
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26. Phillips Curve and Expectation Augmented PC (NAIRU)
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29. Expectation Augmented Phillips Curve
b =1
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30. Expectation die very slowly.
Inflation
Rational Expectation
Time
Deflation
Expectation die very slowly.
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31. Inflation and Unemployment with Static Expectation
b =1
Unemp. rate
Inflation 6 8 12 1 5 7 11 2 4 10 3 9 -1 -2 -3 -4
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32. Link Between Unemployment and Inflation
Grate
gn =7
gn =4
gn =5
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33. Evidence of the Phillips Curve in the UK
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34. Wage Price Spiral: Modernisation or Negotiation?
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35. Price Level to Inflation Rate
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36. Inflation to Aggregate Supply or Expectation Augmented Phillips Curve
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37. Inflation, Output and Unemployment in the Short Run
LAS o
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38. Inflation, Output and Unemployment in the Short Run
LAS
AS=f(w,pe)
AD =f(M,G, T) o
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39. Wage Setting and Price Setting
Real Wage
Firms set price
Z includes
Tax
Benefit
Reservation wage
Bargaining power
Minimum wage
Structure of labour market
Unions set wage rate Un
Unemployment rate
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40. Derivation of aggregate supply curve for the economy using price setting and wage setting relations
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41. A natural rate of unemployment is obtained by intersection of price setting and wage setting relations
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42. Friedman (1966, 1968) and Phelps (1967) natural rate of unemployment hypothesis
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43. Natural Rate of Unemployment Hypothesis
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44. Adaptive and Rational Expectation Views on a Positive Demand Shock
LAS
SAS c P2 b P1 P a P0
AD1
AD0 Yn
Reply to demand shock
Adaptive Expectation: a to b to c
Rational expectation: a to c Y
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45. Inflation is a Monetary Phenomenon
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46. Exercise Should wage rises of workers (fire fighters)
come from modernisation of services as suggested by the government or by the negotiation between the unions and the government?
Natural rate of unemployment and price and wage bargaining
Aggregate supply
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