Phillips curve

During the last two decades, the relationship between inflation and unemployment has been a topic of ongoing and continuous research. The conventional formulation of the inflation and unemployment is called The Phillips Curve, wich is the original finding of Phillips (1958). It was thought that The Phillips Curve represents an exploltable trade-off between inflation and unemployment rates in theshort-run, but is not identifiable in the long-run. The original Phillips Curve assumes that there is no natural rates of unemplyment so that the trade-off is possible. However, many debates form economists such as Friedman (1968) and Phelps (1967) believe that because the money is neutral in the long-run, the unemployment rate will be at its natural level eventually, so that the rationalexpectation of Phillips Curve does not hold either in the long-run or the short-run.

Origins of Phillips Curve

Irving Fisher (1926) was the first to document such relatinship using data from the United States. His statement of the quantity theory of money recognised the possible effects of money and inflation over the course of a business cycle. Then, the Phillips Curve is named for a NewZealand-born economist A. W. Phillips, who published an article in 1958 showing a negative relationship between the rate of unemployment and the rate of inflation in nearly 100 years of data fron the United Kingdom (Phillips, 1958)

Phillips’ works was among the first formal analyses of the relationship between inflation and real economic activity.

The Long Run Phillips Curve

According to Lacker andWeinberg (2007), by the 1960s, the Phillips curve trade-off had become an essential part to the keynesian approach to macroeconomics and attrached greater attention ever since the Second World War. Many economists argued that the government could use fiscl policy, which implies that goverment spending or cutting tax to stimulate the economy to achieve full employment with a fair amount ofcertaintu about how much cost would be in terms of increased inflaction, or alternatively achieve this by monetary policy. However, many economists continued to emphasise the limitations on the ability of rising inflation to bring down the unemployment rate in a sustained way, and denied such approach, especially in the long run.

The leading study of this view was Milton Friedman, whose Nobel Prizeaward would cite this Phillips corve work. In this published paper in the American Economic Review, based on his presidential address to the American Economic Association, friedman (1968) began his discussion of monetary policy about what monetary policy, cannot do, and explained that one thing monetary policy nanot do, other than for only a short period of time, is to pick a combination ofinflation and unemployment on the Phillips Curve. At about the same time, Phelps (1967) also published a paper denying the existence of a long-run trade-off between inflation and unemployment

Friedman and Phelps based their conclusions on the classic theory, wich points to growth in the money supply as the primary determinant of inflation. However, Mankiw (2004) emphasises that the classical theorystates that the monetary growth does not have real effect, wich implies that it merely alters all prices and nominal incomes, but it does no influence factors that determine the unemployment rate. Friedman and Phelps conclused that there is no reason to think the inflation rate to be related to the unemployment rate in the long run ( Friedman, 1968 and Phelps, 1967)

Expectations of Phillips CurveFrom initial data based short run correlation between inflation and unemployment, to the theory based long run trade-off between those two variables, there has been much debate around questioning about wich one provides a better offer to policymakers. Friedman (1968) and Phelps (1967) help to explain the short run and long run relationship between inflation and unemployment by introduciong a...