Download Unemployment, NAIRU and the Phillips Curve

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Unemployment,
NAIRU and
the Phillips Curve
Copyright 2007 – Biz/ed
http://www.bized.co.uk
Unemployment, NAIRU and the
Phillips Curve
Copyright 2007 – Biz/ed
http://www.bized.co.uk
Types of Unemployment
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Types of Unemployment
• Frictional Unemployment:
• Unemployment caused
when people move from job to job
and claim benefit in the meantime
• The quality of the information
available for job seekers is crucial
to the extent of the seriousness
of frictional unemployment
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Types of Unemployment
• Structural Unemployment:
• Unemployment caused
as a result of the decline of
industries and the inability of
former employees to move
into jobs being created
in new industries
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Types of Unemployment
The demand for lifeguard services tends to
exist in the summer but nothing like as much in
the winter – an example of seasonal
unemployment.
Copyright: Swiassmautz, http://www.sxc.hu
• Seasonal
Unemployment:
• Unemployment
caused because
of the seasonal
nature of
employment –
tourism, skiing,
cricketers, beach
lifeguards, etc.
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Types of Unemployment
A fall in aggregate demand can lead to a decline in
spending forcing businesses across the economy into
closing with damaging effects on employment as a
result.
Copyright: Beeline, http://www.sxc.hu
• Demand Deficient:
• Caused by a general lack
of demand in the
economy – this type
of unemployment
may be widespread
across a range
of industries and sectors
• Keynes saw
unemployment as
primarily a lack of
demand in the economy
which could be influenced
by the government
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Types of Unemployment
• Technological Unemployment:
• Unemployment caused when
developments in technology replace
human effort – e.g in manufacturing,
administration etc.
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Unemployment
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Unemployment
• Short run and long run unemployment:
• Classical theory – short run
unemployment is a temporary
phenomenon; wages will fall
and the labour market will move back
into equilibrium
• Long run – unemployment
will be ‘voluntary’
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Unemployment
• Keynesian Unemployment:
• Unemployment in the long run may
remain stubbornly high because of
imperfections in the market –
‘sticky wages’
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Inflation
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Inflation
• Anticipated Inflation:
• Occurs where individuals
and groups correctly factor in
expected changes in inflation
into decision making
e.g. wage negotiations,
contract discussions, etc.
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Inflation
• Unanticipated Inflation:
• Where changes in inflation are not factored
into decision making – can lead to:
– Changes in distribution of income – e.g.factoring in
inflation above actual levels in wage negotiations
may lead to a redistribution of income from
employers to employees
– Effects on Employment – e.g. wage settlements
higher than inflation due to incorrect anticipation
of inflation imposes costs on employers
and may lead to job losses
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Inflation and Unemployment using AS/AD
AS2
Inflation
AS1
The
The
short
riserun
in AD
fall leads
in unemployment
to ahas
fall in
is only
Assume
the
economy
an inflation
temporary;
unemployment
as
AS
but
shifts,
inflationary
unemployment
rate of 2% and a level of national will
start
pressures
to rise again
push and
inflation
the economy
up to 3.75%.
will
end
income
giving
an unemployment
rate
upProducers
inofthe
long
try
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toinexpand
aforposition
output
withbut at
4%.
AD
rises
some
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unemployment
increased cost
at –4%
employing
but with higher
more
inflation.
expensive
Expansionary
capital, paying
fiscalworkers
or monetary
more
policy
to dowill
work
onlyetc.
lead
Increased
to reductions
cost results
in
in
unemployment
a shift in AS to
in the
the left
short
– workers
run. In the
start
long
to
runbeunemployment
laid off.
will return to its natural
rate. Attempts to reduce unemployment
below the natural rate will be inflationary.
4.0%
3.75%
2%
AD2
AD1
U = 4%
U = 3%
Real National Income
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The Philips Curve
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The Phillips Curve
• 1958 – Professor A.W. Phillips
• Expressed a statistical relationship
between the rate of growth
of money wages and unemployment
from 1861 – 1957
• Rate of growth of money wages
linked to inflationary pressure
• Led to a theory expressing a trade-off
between inflation and unemployment
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The Phillips Curve
Wage growth %
(Inflation)
The Phillips Curve shows an inverse relationship
between inflation and unemployment. It suggested
that if governments wanted to reduce
unemployment it had to accept higher inflation as a
trade-off.
2.5%
Money illusion – wage rates rising but individuals
not factoring in inflation on real wage rates.
1.5%
4%
6%
PC1
Unemployment (%)
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The Phillips Curve
• Problems:
• 1970s – Inflation
and unemployment rising
at the same time – stagflation
• Phillips Curve redundant?
• Or was it moving?
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The Phillips Curve
Wage growth %
(Inflation)
An inward shift of the Phillips Curve would result in
lower unemployment levels associated with higher
inflation.
3.0%
1.5%
4%
6%
PC1
Unemployment (%)
PC2
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The Phillips Curve
Inflation
Long Run PC
To
There
Assume
counter
is athe
short
theeconomy
rise
term
in fall
unemployment,
starts
in unemployment
with an inflation
government
butrate
at aonce
of
cost
again
1% of
but
injects
higher
very resources
high
inflation.
unemployment
Individuals
into the economy
at
now
7%.
base
– the
their
result is
wage
a
Government
short-term
negotiations
fall
takes
in unemployment
onmeasures
expectations
to reduce
but
of higher inflation
inflation.in
the
This
unemployment
next
higher
period.
inflation
Ifbyhigher
an
fuels
expansionary
wages
furtherare
expectation
granted
fiscal policy
then
of higher
that
firms
costs
inflation
pushes
rise
and
AD
– they
to
sothe
the
start
right
process
to(see
shed
continues.
the
labour
AD/AS
and
The
diagram
long run
on
unemployment
Phillips
slide 15)
Curve iscreeps
verticalback
at the
upnatural
to 7% again.
rate of
unemployment. This is how economists have explained
the movements in the Phillips Curve and it is termed the
Expectations Augmented Phillips Curve.
3.0%
2.0%
1.0%
PC1
7%
PC3
PC2
Unemployment
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The Phillips Curve
• Where the long run Phillips Curve
cuts the horizontal axis would be
the rate of unemployment at which
inflation was constant –
the so-called
Non-Accelerating Inflation
Rate of Unemployment
(NAIRU)
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The Phillips Curve
• To reduce unemployment
to below the natural rate
would necessitate:
1. Influencing expectations –
persuading individuals that inflation
was going to fall
2. Boosting the supply side of the
economy - increase capacity
(pushing the PC curve outwards)
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The Phillips Curve
• Supply side policies have been focused on:
• Education:
–
–
–
–
Boosting the number of those staying on at school
Boosting numbers going to university
Lifelong learning
Vocational education
• Welfare benefits:
– The working family tax credit
– Incentives to work
• Labour market flexibility
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The Phillips Curve
• Expectations have been centred on:
– Operational independence of the Bank of
England
– Tight control
of public sector pay
The independence of the Bank of England has taken away interest rate decision making from the
government who may have been motivated by political ends – this has had the effect of influencing
expectations.
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