Unemployment,
NAIRU and
the Phillips Curve
Unemployment, NAIRU and the
Phillips Curve
Types of Unemployment


Unemployment caused
when people move from job to job
and claim benefit in the meantime
Search or Frictional
Unemployment:
Types of Unemployment


Unemployment caused
as a result of the decline of industries
and the inability of former employees to
move into jobs being created
in new industries
Structural Unemployment:
Types of Unemployment

The demand for lifeguard services tends to
exist in the summer but nothing like as much in
the winter –
Copyright: Swiassmautz, http://www.sxc.hu

Unemployment
caused because the
job can only be
done at certain
times of the year
tourism, skiing,
cricketers, beach
lifeguards, etc.
Seasonal
Unemployment:
Types of Unemployment


A fall in aggregate demand can lead to a decline in
spending forcing businesses across the economy into
closing with damaging effects on employment as a
result.
Copyright: Beeline, http://www.sxc.hu

Caused by a general lack of
demand in the economy –
this type of unemployment
may be widespread across a
range of industries and
sectors
Keynes saw unemployment
as primarily a lack of
demand in the economy
which could be influenced by
the government
Cyclical or Demand
Deficient
Types of Unemployment


Unemployment caused when
developments in machines and computers
replace human effort – e.g in
manufacturing, administration etc.
Technological Unemployment:
Unemployment


Keynesian Unemployment:
Unemployment in the long run may
remain high because of imperfections
in the market – ‘sticky wages’
Inflation
What is Inflation?



The rate at which P  for goods and
services
 purchasing power 
Inflation is measured by CPI Consumer
Prices Index
How is Inflation measured?
Causes of Inflation
Demand Pull
 Rising AD






Cost Push
Diminishing resources
External Shocks
Wage Push
M prices rising.
Tax Push
Inflation 1993 - 2017
Who Loses from inflation?




Creditors
Businesses
Especially with a high PED
The country as a whole
Who gains?



Debtors
Businesses with a low PED?
People with assets with high inflation
Inflation and Unemployment using AS/AD
AS2
Inflation
AS1
Assume the economy has an inflation
rate of 2% and a level of national
The  AD  a unemployment but
income giving an unemployment rate
The
short run
 unemployment
is only
inflationary
pressures
push inflation
up
of 4%. AD rises for some reason.
temporary;
as AS shifts,
unemployment

to 3.75%. Producers
try to
expand
and
the
economy
will
end
up
in
the
long
run
output but at increased cost –
in
a position
withexpensive
unemployment
at 4% but
employing
more
capital,
with
higher
inflation.
fiscal or
paying
workers
moreExpansionary
to do work etc.
monetary
policy
will
only
→

in
Increased cost results in a shift in AS to
unemployment
in the
the long
the left – workers
startshort
to berun.
laidInoff.
run unemployment will return to its natural
rate. Attempts to reduce unemployment
below the natural rate will be inflationary.
4.0%
3.75%
2%
AD2
AD1
U = 4%
U = 3%
Real National Income
The Phillips Curve

1958 – Professor A.W. Phillips
There is statistical relationship between the
rate of growth of money wages and
unemployment from 1861 – 1957

Rate of growth of money wages
linked to inflationary pressure

Led to a theory = there is a trade-off
between inflation and unemployment

The Phillips Curve
Wage growth %
(Inflation)
The Phillips Curve shows an inverse
relationship between inflation and
unemployment. It suggested that if
governments wanted to reduce
unemployment it had to accept higher
inflation as a trade-off.
2.5%
Money illusion – wage rates rising but
individuals not factoring in inflation on real
wage rates.
1.5%
4%
6%
PC1
Unemployment (%)
The Phillips Curve




Problems:
1970s – Inflation
and unemployment rising
at the same time – stagflation
Phillips Curve redundant?
Or was it moving?
The Phillips Curve
Wage growth %
(Inflation)
An inward shift of the Phillips Curve would result in
lower unemployment levels associated with higher
inflation.
3.0%
1.5%
4%
6%
PC1
PC2
Unemployment (%)
The Phillips Curve
Inflation
Long Run PC
There is a short term fall in unemployment but at a
Assume
theinflation.
economyIndividuals
starts withnow
an inflation
rate of
cost
of higher
base their
To
counter
the
riseunemployment
in unemployment,
government once
1%
but
very
high
at
7%.
wage negotiations on expectations of higher inflation in
again injects resources
into the economy
– the result is
measures
theGovernment
next period.takes
If higher
wages to
arereduce
granted then firms
aunemployment
short-term fallby
in unemployment
but
higher
inflation.
fiscal
policy
that
costs
rise – they startan
to expansionary
shed labour and
This
higher
inflation
fuels
further
expectation
of higher
pushes
AD
to
the
right
(see
the
AD/AS
diagram
on
unemployment creeps back up to 7% again.
inflation
slide 15)and so the process continues. The long run
Phillips Curve is vertical at the natural rate of
unemployment. This is how economists have explained
the movements in the Phillips Curve and it is termed the
Expectations Augmented Phillips Curve.
3.0%
2.0%
1.0%
PC3
7%
PC1
PC2
Unemployment
Friedman’s Criticisms





Friedman said the relationship only held in
the short run
In the long run there was no trade off
The position of the PC was determined by
peoples’ expectations of inflation.
then the curve would shift outwards and vice
versa.
This was the EXPECTATIONS AUGMENTED
PHILLIPS CURVE
Searching for the Phillips
Curve



What factors cause people to change
their inflation expectations?
Shocks (oil price changes)
Macroeconomic policy mismanagement
NAIRU




U* = Nairu
If U <U* inflationary expectations rise,
therefore Inflation will accelerate
If U=U* stability
If U>U* disinflation.
The Phillips Curve



To reduce unemployment
to below the natural rate
would necessitate:
Influencing expectations – persuading
individuals that inflation was going to fall
Boosting the supply side of the economy increase capacity (pushing the PC curve
outwards)
The Phillips Curve


Supply side policies have been focused on:
Education:




Boosting the number of those staying on at school
Boosting numbers going to university
Lifelong learning
Vocational education