Phillips curve, Managerial Economics


The Phillips  curve,  named  after  A.  W.  Phillips,  describes  the  relationship between unemployment  and  inflation. In  1958  Phillips, then  professor at London School  of  Economics,  took  time  series data  on  the rate  of unemployment and  the  rate of increase in nominal wage rate  for  the United Kingdom for the period 1861-1  957 and attempted to e'stablish a relationship. He took a simple linear equation of the following  form: 

w = a - bu

where  w  is the rate of wage  increase, a and b are constants and u is the rate of unemployment. He  found  that  there  exists an inverse  relationship between  w and u, with the implication  that lower rate of unemployment is associated with higher rate  of  wage  increase.  The  policy implication of  such a  result  was astounding  - an  economy cannot have both low  inflation  and  low unemployment simultaneously. In order to contain unemployment an economy has to tolerate a higher rate of wage increase and vice versa. 

Subsequent  to the publication of  the results by  Phillips,  economists followed suit  and  attempted  similar exercises for  other countries. Some of  the studies carried out refinements to the simple equation estimated by Phillips such as the use of inflation (the rate of increase in prices) instead of wage rate increase. 1n/ many cases the scatter of plot of variables appeared to be a curve, convex to the/ origin. As empirical studies reinforced the inverse relationship between the rate: of  inflation and  the rate of unemployment the Phillips curve  soon became an: important tool of policy analysis. The prescription was clear: during periods of high unemployment the government should  follow an expansionary monetary policy which  leaves more money  in the hands of people. It may  accelerate the rate of inflation while lowering unemployment.  

Posted Date: 10/26/2012 6:13:19 AM | Location : United States

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