Phillips curve

The Phillips curve is an economic model that explains the relationship between the change of nominal wages and prices on the one hand and unemployment on the other side. The Phillips curve was published in 1958 by the English statistician and economist Alban William Housego Phillips. However, as early as 1926 Irving Fisher pointed out in an essay on this relationship for the United States.

The Phillips curve has since been modified several times, as Paul Samuelson and Robert Merton Solow 1960 for the so-called extended Phillips curve. This establishes a connection between unemployment and the change in the inflation rate. In the literature, however, there are other definitions of the Phillips curves. Here, the original Phillips curve of change in nominal wages and the extended (modified) Phillips curve refers to the rate of inflation in relation to unemployment.

History

The original Phillips curve simply stated an empirical link between the nominal wage growth rate and underemployment. We investigated the period 1861 to 1957 in the UK. Phillips' thoughts were that the workers at a high level of employment have a higher bargaining power and thus can enforce higher wages. The relationship described is explicitly turned not to understand that strong wage increases lead to higher employment in the sense. It is important to note that Phillips put his investigations no macroeconomic model is based.

This was made ​​up by Paul A. Samuelson and Robert M. Solow in the 1960s with the development of the modified Phillips curve. The modified Phillips curve derives a permanent " trade-off " of inflation and unemployment ago. The sensitivity of this model was that many governments it went out later that they could implement any combination of unemployment and inflation. So Helmut Schmidt said: "Five percent inflation are easier to bear than five percent unemployment ."

In the 1970s and 1980s, but disappeared in the empirical relationship between unemployment and inflation. Stagflation - the " two-headed monster " - in the form of inflation and high unemployment made ​​spreading. Already in the late 1960s attacked Milton Friedman, the Nobel Laureate in Economics in 1976, and Edmund S. Phelps, the Nobel Laureate in Economics in 2006, independently, the idea of the Phillips curve. At that time, their criticism was, however, paid little attention to what changed in the 1970s. How should a relationship between a nominal size as inflation and real variables such as unemployment, long-term relationships, but applies when the long -run neutrality of money, asked the critics. This could only be the case if a permanent money illusion would. If workers anticipate inflation correctly, which can be assumed as a rule, inflation has no real effects. The expected modified Phillips curve relates these relationships with a. On the Phillips curve based the political science model of party difference hypothesis.

Keynesian Phillips curve

Schmidt used the modified Phillips curve, in fact he was a student of Karl Schiller a supporter of the post-war Keynesian economics. Strictly according to John Maynard Keynes, there is no real choice between inflation and unemployment, since, according to Keynesian understanding of monetary policy in the long run can have an influence on growth and employment, while inflation than core inflation has been simplified form. In other words, the economic policy can select Keynesianism no inflation - unemployment combinations, but only influence on growth-enhancing policies the level of employment. Further developments were made by both the neoclassical synthesis as well as by the neoliberal turn, founded by Edmund S. Phelps and Milton Friedman.

Monetarist Phillips curve

The monetarists to Milton Friedman, Karl Brunner and Allan H. Meltzer criticize both the modified and the Keynesian Phillips curve as inadequate. They argued that monetary and fiscal policy were only able to influence inflation - but not the level of employment. The reason for this is that monetary policy after monetarist view long term (actually economically correct: medium term) has no real effects, but only causes inflation.

From Keynesian side, the monetarist Phillips curve has undergone a lot of criticism - is the representation of the monetarists, however, that above all, monetary policy can not be used to stimulate economic growth, but should focus on the maintenance of price stability, anyway nothing worth striving for by a monetary policy could be achieved that do not follow strict price stability. Critics see it

• A potential or a wasted economic policy
• A preliminary economic policy and therefore
• Reason for the allegation that the denial that monetary policy have an impact on unemployment, wage levels and share of labor income in national income going out from the motives that no real interest in increasing the level of income, the share of labor income in national income, of national income itself and the reduction of unemployment there.

However, the message of monetarists also includes an optimistic Content: An aligned on disinflation economic policy should not live with the problem of large employment declines.

The monetarist standard model of the Phillips curve looks formally as follows

Here are

With unemployment or unemployment ( new unemployed / Time): called.

The extended Phillips curve

The extended Phillips curve (or modified Phillips curve ) complements the considerations of the Phillips curve for the relationship between inflation and unemployment. Here, the change in inflation is now set with the unemployment rate in relationship.

The following explanations refer to the definition according to Blanchard / Illing. This is due to the better overall view of market activity in inflation analysis.

The expectations-augmented Phillips curve

Wage setters need to define the nominal wages for the next year to predict the rate of inflation over the next year. The following formula shows that for a given expected price level equal to that of the previous year, a lower unemployment leads to higher nominal wages.

With

As a result of higher nominal wages, it comes at a higher price level. Thus therefore a lower unemployment rate leads to a higher price level than the price level from the previous year, ie inflation. This is called a wage-price spiral. Consequently, a low unemployment leads to high nominal wage. Then increase the company their prices and the price level rises. Due to rising price levels, the workers want higher nominal wages in the next wage setting. It follows a constant wage and price inflation.

However, if the inflation rate of the given year is zero, it is logical for the year to predict expected an inflation rate of zero.

In the present situation in Germany is mainly a positive inflation observed, that is, on average, is the inflation rate at 3.1 %. In introduced by Phillips, Samuelson and Solow model, the average inflation rate close to zero.

Justification for the extension

The adjacent figure shows the relationship between inflation and unemployment in the years 1959-1967 is shown graphically. In these years, the prognosis for the Phillips curve with the actual values ​​agreed. In the years of high inflation, there was a low unemployment rate. Again, lay in the years with high unemployment low inflation before. At the beginning of the 1970s, however, no relationship between unemployment and inflation revealed.

This was due to the change in the expectation formation of the wage setters in the course of the 1960s because of a change in inflation. The inflation rate was subject always certain fluctuations; times it has been positive, sometimes negative. But in the 1960s, the inflation rate assumed constant positive values. That is the probability that was followed by a higher rate of inflation to a high inflation rate next year, has been getting bigger. Because of this, the expectations of wage setters changed. This changed the shape of the relationship between unemployment and inflation.

The following formula under the assumption that expectations are formed as follows, to illustrate the relationship:

With

The bigger, the more will increase their inflation expectations, the wage setters. So long as the inflation was around 0, it could be expected that the price level in the current year is approximately the forecast year. During the consideration of Samuelson and Solow period was therefore close to 0

From 1970, the wage setters so altered their expectations due to changes in the inflation rate. They took him to participate in a steadily increasing rate of inflation in subsequent years, which also increased.

Substituting above formula in the first formula, we obtain

Assuming, then one obtains

With a positive, inflation is also on the unemployment rate as a function of the inflation rate last year

The formula looks like this, with a after the inflation of the last period was subtracted on both sides:

Consequently, with the unemployment rate does not change the rate of inflation, but the change in the inflation rate. This means high unemployment leads to falling inflation, low unemployment to an increase in inflation.

This explains the events since the 1970s. increased from 0 to 1 and then a correlation between the unemployment rate and the change in inflation was formed.

The diagram illustrates the relationship of changes in the inflation rate and the unemployment rate for the years since 1980 for Germany dar. this case, a negative relationship between the unemployment rate and the change in the inflation rate can be seen.

It can be seen that at low unemployment, the change in inflation is positive, vice versa, the change in inflation with high unemployment is negative.

Thus, the extended Phillips curve describes the relationship between unemployment and the change in inflation. Furthermore, it is often also referred to as a modified Phillips curve, expectations-augmented Phillips curve or akzelerierende Phillips curve.

The most wage-setting process participants changed their expectations about inflation, whereupon changed the Phillips curve name. The insight obtained therefrom is that the relationship between unemployment and inflation is likely to change with the level and the persistence of inflation.

In order expectations modified Phillips curve

To a further modification of the Phillips curve can be reached by considering the inflation expectations of economic agents. These play an essential role in the effectiveness of monetary policy. Traces a central bank an expansionary monetary policy, then this would have the modified form of a hand, to higher inflation ( monetarist perspective) and other, on the lower interest rates to stimulate the economy and lead to employment growth (movement from (1 ) to (2 ) ).

However, the increase in employment is this understanding, merely due to the fact that when prices rise, and (initially) constant nominal wages, real wages of workers has declined, which is why the company to hire more workers. Since the worker is unable to predict, one speaks in this context of a surprise inflation. So that the modified order expectations Phillips curve corresponds to the modified at least briefly.

In the medium term, however, recognize the workers that their wages have not adjusted to the current inflation, which is why they demand from their employers nominal wage increases to compensate for inflation losses. Accordingly, the nominal wages so ultimately increase at the same rate as inflation, which is why the employment ( at constant inflation) turns back on original level (3). As the matter auftrete with any economic policy to influence inflation, the Phillips curve is vertical in the medium term, the monetarist view.

The model underlying this case the assumption of adaptive expectations, that is, economic agents suspect that the current economic policy will be maintained in the future. We assume, however, that the economic entities of all available relevant information available ( assumption of rational expectations, see Robert E. Lucas, Thomas Sargent, Robert J. Barro and Neil Wallace ), they will anticipate the surprise inflation induced by the central bank and at the same time higher nominal wage demand, so that the route over the short-term perspective is omitted - the Phillips curve would be vertical in the short run.