305_PPT_WK9.1-CH8_STUDENT_FL24

Exam Preparation Tips

• Exam 1 Review: Meet with Grad TAs or instructor during office hours.

• Mid-semester and TA Evaluation: Complete within weekly module.

• ADS Accommodations: Reserve for Exam 2 now.

• Exam 2 Prep: Start immediately, review material after each class for 10-15 minutes, practice examples in reverse order, understand the Phillips curve and labor market curves.

The Phillips Curve Overview

Key Concept

• Monetary policymakers must recognize the trade-off between inflation and unemployment, noting that instability does not imply nonexistence.

Labor Markets and the Phillips Curve

Background

• Developed a model explaining output variations during the business cycle.

• Emphasis on labor markets' role in determining the natural rate of unemployment and price levels.

Phillips Curve Origins

• A.W. Phillips discovered a negative correlation between wage growth (linked to inflation) and unemployment in 1958.

• This relationship, termed the Phillips curve by Samuelson and Solow in 1960, became central to macroeconomic policy.

Inflation and Unemployment Trends

Historical Context (1900-1960)

• Analysis of inflation and unemployment in the U.S. showed low unemployment correlating with high inflation and vice versa.

• Triangles on graph indicate data collected during the Great Depression (1931-1939).

Policy Implications of the Phillips Curve

• Established the notion that low unemployment can coexist with high inflation, and low inflation would correspond with higher unemployment.

• The 1970s experienced shifts indicating the need to reconsider these trade-offs.

Deriving the Phillips Curve

Formula Development

• Wage Setting (WS) and Price Setting (PS) equations used to derive the basic structure of the Phillips Curve, linking unemployment (u) and inflation (π).

• Introduced parameters such as wage rigidity (⍺) affecting wage flexibility related to unemployment changes.

Phillips Curve Equation

• Under specific assumptions of constant inflation expectations, the relationship becomes: [ \pi_t = \pi_e + m + z - \alpha u_t ]

• Where ( \alpha ) indicates wage sensitivity to unemployment rate changes.

Evolution of the Phillips Curve

Changes Over Time

• Originally, a constant inflation rate led to observable trade-offs in the 1960s.

• In the 1970s, a shift occurred as wage-setters reevaluated inflation expectations, leading to a breakdown of the predictable relationship.

The Accelerationist Phillips Curve

• By setting expected inflation as dependent on past inflation rates, the relationship fluctuated, particularly during 1970-1995.

• Introduced changes in inflation rate dynamics, where current unemployment affects future inflation trends.

Impacts and Interpretations

• As expectations evolved, the Phillips curve's predictability diminished, marking distinct phases in macroeconomic thinking about the relationship between unemployment and inflation.