Wither the Phillips Curve?

19
1 Wither the Phillips Curve? Activist demand management or Laissez – faire ?

description

Wither the Phillips Curve?. Activist demand management or Laissez – faire ?. 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 . - PowerPoint PPT Presentation

Transcript of Wither the Phillips Curve?

Page 1: Wither the Phillips Curve?

11

Wither the Phillips Curve?

Activist demand management

or

Laissez – faire ?

Page 2: Wither the Phillips Curve?

22

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.

Page 3: Wither the Phillips Curve?

33

Phillips Curve, United States,

1961–1969

Page 4: Wither the Phillips Curve?

44

United States1955–2000

The relationship broke down when policymakers tried to apply it no evidence of a long-run Phillips Curve.

Page 5: Wither the Phillips Curve?

55

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.

Page 6: Wither the Phillips Curve?

66

Aggregate Demand and Supply Phillips Curve

Page 7: Wither the Phillips Curve?

77

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).

Page 8: Wither the Phillips Curve?

88

Inflation, Unemployment, and Wage Expectations

Page 9: Wither the Phillips Curve?

99

Inflation, Unemployment, and Inventories

Page 10: Wither the Phillips Curve?

1010

Inflation, Unemployment, and Wage Controls

Page 11: Wither the Phillips Curve?

1111

Expectations Formation

Adaptive Expectations: expectations of the future based on history

The public acts on its expectations The present depends on the past

Page 12: Wither the Phillips Curve?

1212

Expectations FormationRational 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

Page 13: Wither the Phillips Curve?

1313

Time Inconsistency: Kydland & PrescottA policy is time inconsistent if it seems a good idea at one time but becomes a bad idea later. – The way people anticipate and react to a policy

may make a “good” policy “bad”Time inconsistency hurts the Fed’s credibility. – It’s hard to believe the Fed will stick to a tight

money policy once unemployment rises.– People anticipate monetary easing and inflation

INFLATION

Page 14: Wither the Phillips Curve?

1414

Time Inconsistency:

An Example

Page 15: Wither the Phillips Curve?

1515

The Political Business Cycle:If a short-run Phillips Curve trade-off exists, an incumbent administration may hype demand and lower unemployment before an election … and then rein prices in with a recession after the election.

Page 16: Wither the Phillips Curve?

1616

The Political Business Cycle

Page 17: Wither the Phillips Curve?

1717

Real Business Cycles: Kydland and PrescottRecessions and expansions may be triggered by real shocks to the economy.–Oil price shocks in the early 1970s

higher production costs inward shift of AS severe recession of 1973-1975.

Technological or productivity shocks may also cause expansions or contractions.– Gone fish’n’ in the 1930s?

“Real business cycles” are supply-side cycles, not demand-side cycles.

Page 18: Wither the Phillips Curve?

1818

Real Business Cycles in Pictures

Page 19: Wither the Phillips Curve?

1919

The Government Budget ConstraintBudget constraint highlights the relation between monetary and fiscal policy:G - T = Bonds To Public+ Bonds to Fed

M = change in the money supply m = Money multiplier

M = m x Bonds to Fed(G – T) is the fiscal surplus or deficit.

Governments can offset the need to tax or to borrow from the public by “printing” money

Inflation Tax.