NOTES: The Phillip’s Curve

## McCaffery © S.07, F12 Module 34

http://www.reffonomics.com/TRB/chapter29/PhillipsCurveIndexLesson3.swf

The Phillip’s curve shows an inverse relationship between inflation and unemployment. Originally it was thought of as a ‘set curve’ offering a “menu” of combinations of the two (inflation rates paired with unemployment rates). Later as the relationship didn’t seem to hold, the curve was thought to “drift”.

The Phillip’s Curve has a Long-Run and a Short-Run component. It is best to discuss these separately. You will probably never have to shift both at once.

THE SHORT-RUN PHILLIP’S CURVE

NRU

7%

3%

### THE LONG-RUN PHILLIP’S CURVE

LR-PC (NRU)

5.5%

UNEMPLOYMENT

Continued on back

LR-PC (NRU)

SR-PC

UNEMPLOYMENT

1976-79, 1984-89, and 2001-05 are periods when it appeared to have been stable or maybe we are seeing something that just is not there. We will pretend that this stability is possible for basic macroeconomics.

The Long-Run Phillip’s Curve is not only the NRU but also the Non-Accelerating Inflation Rate of Unemployment (NAIRU). This is quite a mouthful and most people give it up and just refer to it as the Natural Rate of Unemployment (NRU). But the name NAIRU is descriptive of what it means, which is: there exists a level of unemployment which does not drive inflation changes. Having too little unemployment generates wage and then price inflation, and too much unemployment causes wages and then prices to fall. This special level of unemployment, the NRU, IS NOT a constant. It varies based on the conditions and restrictions society places upon it. As taken from the Krugman/Wells textbook, here is a sampling of things that can change the NAIRU or NRU. (By-the-way, the 2006 Nobel Prize in Economics went to Phelps, yes Phelps, for his work on the Long Run Phillips Curve.)

Changes in the labor force characteristics. Age, sex, number of married both employed couples, number of new workers entering the labor force, structural changes in demand for labor skills, educational attainment level of the workers or requirements of the jobs.

Changes of government policies. Minimum wage, unemployment compensation, job training programs, employment subsidies to workers or the employers.

Changes in Productivity. Increases in productivity w/o wage increases makes workers more desirable, and slowing of productivity w/o a corresponding slowing of wage increases makes workers less desirable.

Changes in Labor Market Institutions. Power of labor unions to negotiate wages above equilibrium level, number of and efficiency of temporary employment agencies, the efficacy of the internet for job searches.

Look at these four and consider their affect on frictional and structural unemployment. As the combination of frictional and structural declines so does the NRU, as the combo increases so does the NRU.

Currently, the inability to sell a house so as to move to take a new job has caused the NRU to rise.