Stagflation And Phillips Curve

By: EconomyWatch   Date: 14 October 2010

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Stagflation and Phillips curve goes hand in hand in modern macroeconomics to depict a period of uncontrollable price inflation combined with slow output growth.
Stagflation and Phillips curve
Stagflation brings up unemployment. During the 1970s, an appreciable number of countries in the world underwent high levels of both unemployment and inflation and it came to be known as stagflation. Theories of Phillips curve contradict the idea. A group of renowned economists, steered by Milton Friedman established the idea that the failure of the relationship called for a return to non-interventionist, free market policies. The previous idea of explaining the cause of stagflation was discarded by most of the macro-economists.

The usual way of choosing one policy over the other is through trading-off between two options. But this theory is not applied while dealing with economic policy. The economic policy performance is non-monotonic towards target value. This opposes the traditional trade-off, which entails that no conflict exists between the two targets.
Phillips curve
The Phillips curve contradicts the traditional idea of explaining stagflation through the relationship between unemployment and the rate of inflation in an economy. It states that the rate of change in wages paid to labor will be higher, if unemployment goes down in an economy.
History of Phillips curve
In 1958, Alban William Phillips, a renowned economist wrote a paper on the relationship between unemployment and the rate of change of money wage, which was published in the quarterly journal Economica. In that paper, Phillips gave a description about the inverse relationship between the money wage changes and unemployment in the British economy. In 1960, Robert Solow reestablished Phillip's work.
NAIRU (Non-Accelerating Inflation Rate of Unemployment)
This new theories clearly explained stagflation. This theory established that in the long run, only a single rate of unemployment existed to be consistent with a stable rate of inflation and eventually the long-run Phillips Curve existed as vertical. This establishes the fact that there was no trade-off between inflation and unemployment. Edmund Phelps was awarded the 2006 Nobel Prize in Economics for this remarkable work.


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