Phillips Curve - Encyclopedia of Economics
This article explains the origin of the Phillips Curve and subsequent theoretical reactions to it. The Phillips Curve represents the negative relationship between unemployment and inflation. This concept was further supported by Lipsey’s discovery of a negative relationship between wage inflation and the demand for labor and Hansen’s definition of frictional unemployment. The Phillips Curve refuted the Keynsian assumption that inflation only occurred after full employment has been reached. This was largely because when unemployment rose, there was no observable decrease in consumer prices. However, commodity prices are less sticky and are more reactive to demand changes. This assumption was also challenged during the 50’s and 60’s, when there was considerable inflation before full employment was reached.
During the 70’s, both unemployment and inflation increased. The Philips curve was seemingly refuted. Some argued that this was rather an indication of a rightward shift in the Philips curve due to external shocks (namely the increase in the labor supply due to women and teenagers and increases in the cost of resources). Monetarist theory, on the other hand, argued that the Philips curve would not explain long run trends. Instead, monetarists believed that real wages are the driving force behind all variation in the labor market. Changes in the equilibrium come from lags in information. (E.g., when the real wage declines, firms are more likely to realize it first. They will offer workers higher nominal wages, which the new workers will later refuse when they realize that the purchasing power of their wages is actually not to their liking and equilibrium will be restored.) Another argument popularized by “new classicist” theory states that inflation has no role whatsoever on unemployment as its trends are predictable, and rational economic actors will therefore adjust their behavior accordingly. Instead of variation in unemployment coming from judgment errors on the part of workers, instead these errors are made on the part of firms when they believe that the price of their good alone is rising independent of the prices of other goods, and attempt to maximize their profits accordingly.
If you’re looking to learn about the Phillips Curve, this article is not the way to do it. I have an understanding of how the Phillips Curve operates, but I don’t understand how it was created or the micro nuances of its behavior (aside from what I can logically work out on my own). The article is very useful in describing the debate over the credibility of the Phillips Curve.
Greenwald, Encyclopedia of Economics, pp. 778-782 (expect a more complete citation later)
