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Chapter 8: Phillips curve, the Natural rate of Unemployment and Inflation

Chapter 8: Phillips curve, the Natural rate of Unemployment and Inflation. More detailed analysis of the last chapters Important chapter to enhance your understanding about how policy was/is made. A. William Phillips. Resume:

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Chapter 8: Phillips curve, the Natural rate of Unemployment and Inflation

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  1. Chapter 8: Phillips curve, the Natural rate of Unemployment and Inflation • More detailed analysis of the last chapters • Important chapter to enhance your understanding about how policy was/is made

  2. A. William Phillips • Resume: • Professor of Economics at LSE, U o Auckland and Australian National University • - Crocodile Hunter • Mine worker • Cinema manager • Prisoner of war • . • . • .

  3. Inflation and Unemployment in US 1900-1960 Negative relation!

  4. Model • Start with the AS equation from Chapter 7 • Now assume a more explicit form for F(u,z): • AS curve: • With some manipulation (just trust me!)

  5. Phillips curve • Can think of Phillips curve as the AS curve: • But now assume = 0 •  Original Phillips curve • Implies the so called “Wage-Price spiral” • Low unemployment  Higher nominal wage • Higher nominal wage  Increase in price level • Higher price level  Higher nominal wage • Higher nominal wage  Increase in prices……….

  6. Inflation and Unemployment in US 1948-1969

  7. Inflation and Unemployment in US 1970-2010 No apparent relation!

  8. Expectations augmented Phillips curve Average inflation for 1915-1969 and 1969-2013

  9. Expectations augmented Phillips curve • Add time subscripts and assume • In this case, the Phillips curve becomes: • Using the approximation θ = 1 • It is the change in inflation rather than inflation on the LHS! • Trade-off between unemployment and the change in inflation!

  10. Estimating the Phillips curve

  11. Non-accelerating inflation rate of unemployment (NAIRU) NRU is defined as when π = πe In this case, the Phillips curve becomes: Rewrite the Phillips curve as: Whenever ut < un Increase in inflation Whenever ut > un Decrease in inflation

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