The Evolution and Policy Implications of the Philips Curve Analysis

Only available on StudyMode
  • Download(s) : 292
  • Published : July 3, 2012
Open Document
Text Preview
Thomas M. Humphrey

At the core of modern macroeconomics is some
version or another of the famous Phillips curve relationship between inflation and unemployment. The Phillips curve, both in itspriginal and more recently
reformulated expectations-augmented versions, has
two main uses. In theoretical models of inflation, it
provides the so-called “missing equation” that explains how changes in nominal income divide themselves into price and quantity components. On the policy front, it specifies conditions contributing to

the effectiveness (or lack thereof) of expansionary
and disinflationary policies. For example, in its
expectations-augmented form, it predicts that the
power of expansionary measures to stimulate real
activity depends critically upon how price anticipations are formed. Similarly, it predicts that disinflationary policy will either work slowly (and painfully) or swiftly (and painlessly) depending upon the speed

of adjustment of price expectations. In fact, few
macro policy questions are discussed without at least
some reference to an analytical framework that might
be described in terms of some version of the Phillips
As might be expected from such a widely used tool,
,Phillips curve analysis has hardly stood still since its
beginnings in 1958. Rather it has evolved under the
pressure of events and the progress of economic
theorizing, incorporating at each stage such new
elements as the natural rate hypothesis, the adaptiveexpectations mechanism, and most recently, the rational expectations hypothesis. Each new element expanded its expIanatory p ower.
Each radically
altered its policy implications. As a result, whereas
the Phillips curve was once seen as offering a stable
enduring trade-off for the policymakers to exploit,
it is now widely viewed as offering no trade-off at all.
In short, the original Phillips curve notion of the
potency of activist fine tuning has given way to the
revised Phillips curve notion of policy ineffectiveness.
The purpose of this articIe is to trace the sequence of

steps that led to this change. Accordingly, the paragraphs below sketch the evolution of Phillips curve analysis, emphasizing in particular the theoretical
innovations incorporated into that analysis at each
stage and the policy implications of each innovation.

The idea of an inflation-unemployment trade-off is
hardly new. It was a key component of the monetary
doctrines of David Hume (1752) and Henry Thornton (1802). It was identified statistically by Irving Fisher in 1926, although he viewed causation as
running from inflation to unemployment rather than
vice versa. It was stated in the form of an econometric equation by Jan Tinbergen in 1936 and again by Lawrence Klein and Arthur Goldberger in 1955.
Finally, it was graphed on a scatterplot chart by A. J.
Brown in 1955 and presented in the form of a diagrammatic curve by Paul Sultan in 1957. Despite these early efforts, however, it was not until 1958
that modern Phillips curve analysis can be said to
have begun. That year saw the publication of Professor A. W. Phillips’ famous article in which he fitted a statistical equation w=f (U) to annual data
on percentage rates of change of money wages (w)
and the unemployment rate (U) in the United Kingdom for the period 1861-1913. The result, shown in a chart like Figure 1 with wage inflation measured
verticaIIy and unempIoyment h orizontally, was a
smooth, downward-sloping convex curve that cut the
horizontal axis at a positive level of unemployment.
The curve itself was given a straightforward interpretation : it showed the response of wages to the excess demand for labor as proxied by the inverse of
the unemployment rate. Low unemployment spelled
high excess demand and thus upward pressure on
wages. The greater this excess Iabor demand the

tracking img