Phillips Curve
The Phillips curve is a term in economics developed by A. W. Phillips. The economist asserted that relationships of unemployment and inflation processes have a stable inverse correlation. It is stated that inflation is followed by economic growth, which in its turn should create space for jobs and thus — lower percent of unemployment. Nevertheless, this theoretical concept has been cracked on the ground of experiencing the phenomenon called stagflation, which took place in the seventies of the past century. At that peculiar period, in historical and cultural sense, the level of inflation was extremely high as well as the rates of unemployment were raised.
Definition of the Phillips Curve
The concept that is based on the Phillips curve represents changes of unemployment rates having a predictable impact on price inflation. The correlation between inflation and unemployment is arranged in a form of a reversed curve with a descending slope — axis X for unemployment and axis Y for inflation. Unemployment rates are reduced by increasing inflation and vice versa. However, the given emphasis on coping with unemployment also raises inflation level and vice versa.
In the 1960s there was a certain perception that any financial incentives could raise overall demand and provoke further consequences. The demand for labor raises, the crowd of non-working emploees consequently reduces and companies increase salaries to create a competitive field and find a narrow range of talented applicants. The corporate salary spendings grow and companies shift those wages to customers in a covert form of increased prices.
This system of belief triggered a lot of governments to accept the strategy of "stop-go". It means a target rate of inflation was set, and financial and monetary policies were used to widen or shrink the economy to take the target rate. Neverless, the permanent trade-off between unemployment and inflation cracked down in the decade later with the occurence of stagflation, putting in doubt and questioning the reliability of the Phillips curve.
The Phillips Curve and Stagflation
Stagflation appears when an economy tries to cope with a stagnation of economic growth,inflation with high prices and unemployment rates. This tendency, of course, is clearly contrary to the theory linked to the Phillips curve. The USA never had an experience of dealing with stagflation before, until the seventies brought rising levels of unemployment, which couldn’t macth with declining inflation. During the mid-seventies, the United States economy arranged six quarters of lowered GDP in a row and at the same time augmented the inflation.
Long-term perspective of Phillips Curve
The concept of stagflation and the failure in the Phillips curve made analysts take a closer look at the position of expectations in the dyad of inflation and unemployment. As emploees and customers may adjust their predictions about inflation rates in the foreseeable future, based on present levels of unemployment and inflation, the inverse relationship between inflation and unemployment could remain in the same position only in the short-term perspective.
When the central bank boosts inflation to reduce unemployment level, it may cause a primary shift along the short-term Phillips curve, but as workers' and customers' predictions about inflation correct to the modern environment, in the long view, the Phillips curve can appear outwardly. This is particularly considered to be the situation around the normal unemployment rate or NAIRU (Non Accelerating Inflation Rate of Unemployment), which clearly depicts the usual state of institutional and frictional unemployment in the economy. Thus in the long term, if expectations can transform to changes in the rates of inflation, then the long-term Phillips curve reminds a vertical line at the NAIRU; monetary policy merely increases or decreases the rate of inflation process particular predictions have succeeded themselves out.
During the stagflation times, customers and emploees workers may begin to reason wisely and predict that the rates of inflation must go down as soon as they realize that the currency board plans to deploy on accomodative monetary policy. It may bring an outward shift in the short-term Phillips curve even before the stimulating monetary policy has been implemented, so that even in the short perspective the policy has fewer effects on increasing unemployment, and in effect, also the short-term Phillips curve transfroms into a vertical line at the NAIRU.
Thus, most economists almost don’t refer to the Phillips curve in its original theory as it was represented to be too simple and basic. However nowadays, updated versions of the Phillips curve that take predictions of inflation tendency into account stays relevant. The theory has several names, with some specific variations in its features, however all current versions contain differences between short-run and long-run influence on unemployment. Today new Phillips curve versions have both a short-term Phillips Curve and a long-term Phillips Curve.
