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  The Phillips Curve Examined and Shifts in the Phillips Curve

The Phillips Curve Examined:

The rise of the Phillips curve depends on how sticky wages and prices are. The stickier are wages as well as prices the smaller is the parameter β and the flatter is the Phillips curve. The parameter β varies extensively from country to country and era to era. In the U.S. at present it is about 0.5. While the Phillips curve is flat, even huge movements in the unemployment rate have little effect on the price level. When wages as well as prices are less sticky, the Phillips curve is almost vertical. Then even little movements in the unemployment rate have the potential to cause large changes in the price level.

Whenever unemployment is equivalent to its natural rate, inflation is equivalent to expected inflation. Therefore we can determine the position of the Phillips curve if we know the natural rate of unemployment and the expected rate of inflation. An elevated natural rate moves the Phillips curve right. Elevated expected inflation moves the Phillips curve up. If the earlier forty years have made anything clear it is that the Phillips curve shifts around substantially as both expected inflation and the natural rate change. Neither is a constant. The present natural rate of unemployment u* is between 4.5 and 5 percent. The present rate of expected inflation πe is about 2 percent per year. However both will be different in the future. One other significant factor affects the position of the Phillips curve. Unpleasant supply shocks (like the 1973 tripling of world oil prices) move the Phillips curve up. Complimentary supply shocks (like the 1986 worldwide declines in oil prices) move the Phillips curve down.

Shifts in the Phillips Curve:

637_shifts in philips curve.jpg

Legend: When predictable inflation changes, the position of the Phillips Curve changes too.

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