The Phillips Curve.

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The Phillips Curve

        Economists agree that unemployment and inflation are two of the major macroeconomic problems of the twentieth century. If a relationship between the two existed then this would be a major break through for the macro management of the economy. Phillips’ work was empirical – started with evidence and worked towards a theory. The causation for the Phillips theory was that the level of unemployment caused the rate of change in money wages to be what it was.

‘What economic theory lies behind this?’

        As unemployment decreases the available pull of labour goes down. This means that resources become increasingly scarce and workers can push for higher wage rates. Or as unemployment decreases more people have more income and spend more causing Aggregate Demand to increase leading to Demand Pull Inflation. What Phillips’ curve did propose was that an inverse relationship between unemployment and the rate of change in money wages existed.

‘As a piece of historical economic research the Phillips curve can be seen as a success. However can it be relied upon as a piece of economic theory?’

        No one suggested that the curve should have been in a different place. However it could have been argued that for the first period which he studied the data, 1861 – 1913, were too unreliable. After all, for most of that time there were no government figures for unemployment and many politicians refused to accept that the problem existed.

‘Phillips’ contribution and Keynesian demand management?’

        Phillips’ contribution was made in the heyday of Keynesian economics. Keynesians were in charge of economic policy and were managing the level of demand in the economy in order to achieve full employment. Keynesian economists all accepted that too little demand for goods and services would result in too little demand for labour and hence unemployment. They held that it was the government’s duty to achieve the correct level of demand by manipulating its own spending and tax receipts, or in other words, to have an active fiscal policy. This policy required the government to spend more than it received if the economy had less than full employment. As a consequence, aggregate demand would rise through a multiplier effect and unemployment would fall.

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‘The inflation controversy – Demand-Pull or Cost-Push?’

        Keynesian economists were divided into two camps. Some believed that inflation was caused by too much demand for goods and services, or excess demand i.e. Demand Pull Inflation. Such economists were very enthusiastic about the Phillips curve because it seemed to provide strong evidence for their views. The second camp of Keynesian economists believed that inflation was caused by cost pressures arising from high wage settlements gained by strong trade unions and from increases in import prices i.e. Cost Push Inflation. They were doubtful about the usefulness of the Phillips curve. ...

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