explanation of relation between inflation and unemployment.
Original Phillips curve brought out the
inverse relation between
unemployment and rate of change in money wage. This was
explained in his article, ―The relation
between unemployment and
rate of change of money wage in U.K. 1867
– 1957‖published in
Economica, November, 1958.
Phillips curve shows rate of wage inflation decreases along with
increase in unemployment rate.
Let W be the wage of the current period and the W
-1
the
wage of
the last period. The rate of wage inflation g
w
is defined as
…………..…(1)
With U* representing the natural rate of unemployment, the simple
Phillips
curve can be stated as
………………(2)
Where (epsilon) measures the responsiveness of wage to
unemployment.
The equation state that wage rate is falling when the
unemployment rate exceed the natural rate (U>U*) and rising when
(U
The Phillips curve implies that
wages and prices adjust
slowly to changes in aggregate demand.
9.8.2 Vertical Long
– run Phillips
The macroeconomic relationships given by Phillips curve
were found to be true in the U.K. and the U.S. in 1960s. But the
data for 1970s and 1980s do not corresponds
to simple Phillips
curve.
In the long run any increase in nominal money is
accompanied by same increase in money wage,
prices and
nominal rate of interest. Hence, the real variable remains constant
and output remain at full employment.
In other words, long run equilibrium
of full employment
potential output, real wages and unemployment are not affected by
the inflation rate.
All nominal variables adjust to keep with inflation and
maintain the values of corresponding real variables. It is assumed
1
1
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