The Phillips Curve

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					 The Phillips Curve

Transition from short run to
          long run
    The Phillips Curve Relationship

   Inverse relationship between the
    unemployment rate and the wage inflation
Original Phillips Curve for UK

   Transition period

   Wages & prices are sticky
Canadian data (1940-2002)
Canada: 1960 - 1969
Canadian data: 1960 - 2002
       The Role of Expectations

   The simple Phillips curve does not
    consider expected or anticipated inflation

   Workers are concerned with real wage,
    not nominal wage
   When evaluating a wage increase, they
    compare it to the expected rate of
   In order for a wage increase to be a real
    wage increase, the nominal wage rise
    faster than the inflation rate.
     Expectations augmented PC

2 critical features:

1.   Expected inflation is passed onto actual
2.   Unemployment is at the natural rate
     when actual inflation equals expected
   The role of expected inflation in moving
    the PC adds another automatic adjustment
    mechanism to the aggregate supply side
    of the economy.
     How do expectations change?

2 possibilities:

1.   Adaptive expectations

2.   Rational expectations
         Adaptive expectations

   Individuals are assumed to take an
    average of past actual price levels to form
    their expectation of the current price level.
         Rational expectations

   Individuals are assumed to not make
    systemic errors in forming their
   Expectational errors are immediately
   On average, expectations are correct.
      Sticky prices – rationales

1.   Imperfect information about changes in
2.   Coordination problems
3.   Efficient wages
4.   Menu costs
The important role of expectations

   The Fed chief told lawmakers Feb. 14 that
    ``inflation expectations appear to have
    remained reasonably well anchored.''
    (Bloomberg News, February 26, 2008)
   “U.S. home prices dropped again in
    August and American consumer
    confidence remained at the lowest level in
    two years, reinforcing investors' bleak
    expectations for the economy, reports
    showed Tuesday.” (International Herald
    Tribune, November, 2007)
   “The Consumer Confidence Index, which
    had declined in January, fell sharply in
    February; the Index now stands at 75.0.”
    (Conference Board of Canada, February,