Policy Conflicts and The Phillips Curve:
Policy Conflicts:
In the Long Run it is possible to achieve all 4 macroeconomic objectives.
In the Short run there is a potential for conflict:
1) Trade off between boosting productivity via capital investment and
structural unemployment generated by new machines replacing jobs.
2) Supply Side shocks can cause 2% inflation Target to be temporarily
undershot/overshot, as BOE stabilizes real GDP and Employment.
3) SR Phillips Curve - relationship between Inflation and Employment.
Short Run Phillips Curve:
Phillips curve shows cost push/demand pull inflation and long term
equilibrium in the classical model but in different ways.
Short Run Phillips Curve: A representation of this relationship in the
short-term, where inflation and unemployment are inversely related.
Old PC:
Original Idea: (1950’s)
Inverse relationship between wage growth and unemployment.
- When unemployment is lower - wages are scarce - they have more
bargaining power to push up wages.
- When unemployment is high - high supply of workers and lower
demand for them - wages are low - some workers take wage cuts
New Theory (1960’s):
- Wage rate swapped for inflation - as firms used to be labor intensive if
wage growth was rising, inflation was also rising.
- There is a conflict between inflation and unemployment.
Low Unemployment = High Inflation
Low Inflation = High Unemployment
This is derived from the CLASSICAL model:
, Point A: Full Employment AD=SRAS=LRAS
By taking price across at full employment:
2% inflation
5% NRU
Point B: AD Shift to Right:
If an economy wants to increase growth and reduce unemployment = Shift
AD to right.
Inflation: 3%
NRU 4%
Policy Conflicts:
In the Long Run it is possible to achieve all 4 macroeconomic objectives.
In the Short run there is a potential for conflict:
1) Trade off between boosting productivity via capital investment and
structural unemployment generated by new machines replacing jobs.
2) Supply Side shocks can cause 2% inflation Target to be temporarily
undershot/overshot, as BOE stabilizes real GDP and Employment.
3) SR Phillips Curve - relationship between Inflation and Employment.
Short Run Phillips Curve:
Phillips curve shows cost push/demand pull inflation and long term
equilibrium in the classical model but in different ways.
Short Run Phillips Curve: A representation of this relationship in the
short-term, where inflation and unemployment are inversely related.
Old PC:
Original Idea: (1950’s)
Inverse relationship between wage growth and unemployment.
- When unemployment is lower - wages are scarce - they have more
bargaining power to push up wages.
- When unemployment is high - high supply of workers and lower
demand for them - wages are low - some workers take wage cuts
New Theory (1960’s):
- Wage rate swapped for inflation - as firms used to be labor intensive if
wage growth was rising, inflation was also rising.
- There is a conflict between inflation and unemployment.
Low Unemployment = High Inflation
Low Inflation = High Unemployment
This is derived from the CLASSICAL model:
, Point A: Full Employment AD=SRAS=LRAS
By taking price across at full employment:
2% inflation
5% NRU
Point B: AD Shift to Right:
If an economy wants to increase growth and reduce unemployment = Shift
AD to right.
Inflation: 3%
NRU 4%
