The Phillips Curve: 1900 - 1960
The Early Incarnation, Circa 1960
1970s Stagflation: Why did the Phillips curve vanish?
Is there no inflation – unemployment tradeoff?
Inflation & Expectations: Natural rate hypothesis
•1970-1998:
 t – t-1 = 6.5% – 1.0ut = -1 (ut - 6.5%)
•Acceleration hypothesis: keep ut < uN   rises year after year
•But late 1990s – 2007: “low” unemployment without much
inflation  Expectations augmented Phillips Curve shifts
The Phillips Curve – Differences in the “Natural Rate” Across Countries
Europe in the 1990s
Expectations Augmented Phillips Curve
From our wage setting – price setting model:
Wt = Pte F(ut,z) and Pt = (1+µ) Wt
Let
F(ut,z) = 1 - ut + z
Then Pt = Pte (1 + µ) F(ut,z)
Pt = Pte (1 + µ) (1 - ut + z)
We can then derive
t = te + (µ+z) - ut
where
t = the inflation rate
te = expected inflation rate
 = Sensitivity of wages to the unemployment rate
•When t = te (medium-run equilibrium)
u = (µ+z)/ = “natural rate” of unemployment
Determinants of “Natural” Rate of Unemployment
• µ = Markup over unit labor cost
– Degree of monopoly (elasticities of demand)
– Other input costs: energy/imports/…
• Z = Structural factors
– Unemployment benefits
– Labor militancy
• International competition
• Government stance: Air Traffic Controllers Strike
– Implicit contracts: Japanese life-long jobs
– Structural change
– Hysteresis: History matters
Monetary Policy  Macro-stability
Output, Unemployment, & Inflation
Tools for Disinflation
• Modified Phillips Curve: unemployment and the
change in inflation
• Okun’s Law: output growth and the change in
unemployment
• Aggregate Demand: Money, output, and prices
 Money growth, Output growth, Inflation
Modified Phillips Curve
 t   t   (ut  un )
  1(u  .06)
e
Okun’s Law: The Data
Okun’s Law: The Equation
ut - ut-1 = - 0.4 (gyt - 3%)
gyt must be at least 3% to keep unemployment from rising
WHY?
1. Labor force growth
2.
Increases in labor productivity
Why is the coefficient only 0.4?
• Firms need a minimum number of workers
• Firms hoard labor
• Changes in labor force participation
•When economy tanks, workers drop out of the laborforce
 u doesn’t rise as much as it otherwise would
Okun’s Law Coefficients Across Countries
Country
1960-1980
United States
United Kingdom
Germany*
Japan
1981-1998
0.39
0.15
0.20
0.10
0.42
0.51
0.32
0.20
Okun’s Law
In general, the relation between changes in unemployment and output growth is:
ut  ut 1    (g yt  g y )

gy
: how growth in excess of normal growth
impacts the unemployment rate
: normal growth rate