Phillips curve, Macroeconomics Video Lecture | Macro Economics - B Com

In the late 1950s,
William Phillips noticed a correlation
between unemployment and inflation
and I have a picture of this gentleman right over here,
Irving Fisher
because he actually noticed that relationship a few decades before
but the relationship has taken on Phillips's name really because
his publication kind of captured people's imagination
and the relationship is not that surprising
it seems to fall a little bit out of common sense
but we'll talk about examples that seem to go against this relationship
If I were to plot the unemployment percentage right here
on my horizontal axis
and I plot inflation on my vertical axis,
so let me put inflation here
Then he noticed, (and I'm just gonna pick random data points)
but in one year where there was high inflation, there was low unemployment
and then in another year,
where there was high unemployment, there was low inflation
and it's not clear which one's causing which
or maybe they both circle back on each other
and then in other years, maybe where you had medium inflation
or relatively low unemployment
so he looked at a bunch of years and plotted them on an axis like this
(let me do them all in the same color)
so you take a bunch of years
and you plot them here
so now you have higher inflation, slightly higher unemployment than that year over there
and I could just keep plotting some points over here
you could have deflation
and what he saw is that there's a correlation here
that there's an inverse relationship
that if you were trying to fit a curve to these points
and you could have more points here, I'm just picking them at random,
you could fit a curve that looks something like this
generally saying, when you have high inflation,
so when you're up here, you have high inflation
and low unemployment
the low unemployment part is a good thing
and now here you have low inflation and high unemployment
and if this curve goes below the horizontal axis you would actually have deflation
and it makes reasonable sense
we've kind of talked bout it in common sense terms before
but you can imagine - once again, it's not clear which one's causing which -
but you can imagine a world, just reasoning through it,
that if you have low unemployment, or you could view that as high employment,
one way to view low unemployment is that you have a high utilisation of the labour market
well, now, in this situation, workers have more leverage
and if workers have more leverage
then employers will have to increase wages
to attract and retain employees
they have more leverage and they have more options
there are a lot of people looking to hire them
employers raise wages to attract and retain employees
but of course when you increase wages you're increasing buying power, generally for workers
so this is increasing workers' buying power
which would increase their demand
for goods and services
and if they're increasing the demand for goods and services,
they're going to increase the utilisation of all of the factors of production:
of land, of capital, of entrepreneurship,
and of labour, so that's going to lower unemployment even more
and you can imagine if you already have low unemployment,
and this is just one of the factors of production,
but if you think about all factors of productions, they are probably all highly utilised
the factories are running at close to full capacity
the labour market is running at full capacity
if you increase buying power, if you increase demand in that context,
so demand is going up
lower unemployment, labour utilisation is going down
there's less capacity, more demand
this is going to cause prices to go up
so this is going to cause prices generally to go up
and then if prices go up, now workers have leverage and options of employment
but they also have higher cost
higher cost of living
and this is a very kind of hand, wavy diagram,
but it's just to make you think about the overall dynamics
so workers have more options and leverage
they also have a higher cost of living,
the whole economy is kind of operating at close to full tilt
and so they're going to demand higher wages even more
and then this thing can keep cycling and keep cycling
now, this seems a bit common sense,
but there are exceptions to these
in the 1970s, the US experienced stagflation
and that's kind of the worst: that's high inflation and high unemployment
so that is right over here
and things that could cause it
and particularly what people point to in the 1970s,
and it's always important to realise that in economics people don't know for sure what was the exact cause
and there seldom is only one cause
but one of the things that's often pointed to
is that you had a supply shock
and the supply shock was in oil
it made the cost of producing everything more expensive
and so that just drove the prices up
but really didn't allow the country as a whole to become more productive
one way to think about it is it drove the prices up here
causing a higher cost of living right over here
but this part of this cycle that we associate with low unemployment and high inflation
was not occurring
and because those higher prices were essentially going out of the country,
you could essentially imagine that they were squeezing out people's ability to pay for other things
so the higher cost of living
or the higher prices for oil
you could draw a line from either one and I know it's getting messy now
you can imagine that it inhibited demand for domestic production
so I'll draw "negative feedback" right over there
so it squeezed out people's desire to buy things because they had to pay so much for oil
and there's other explanations for it
when people saw the low unemployment, the government wanted to print even more money
to fuel things, but it did not get this virtual cycle happening
there were some arguments that there were structural reasons
why the economy couldn't adapt properly
so that employees and resources couldn't be allocated efficiently
but the whole point of bringing up the 1970s is to show you that this isn't a law
it's not clear what's causing what
that there was a situation in the 1970s where you had stagflation
and the opposite of that was what we really saw in the late 90s
where you had relatively low inflation and you had relatively low unemployment
so this is a very good situation that we had in the late 90s
and the argument that many people make why we were able to do that,
why this cycle didn't keep going on and on
why the prices didn't go up is that you had this other trend of huge technological improvement
you had computers, and telecommunications, the Internet, this kind of super productivity curve
so even though you had the cycle, you had increased buying power, demand was going up,
the proactivity of the country was increasing so much
that it did not lead to inflation
so that's what threw us there in the late 90s
so, in general, it's a neat thing to think about,
at least to some degree it seems like common sense,
but like in all things in economics, it's always a little bit more nuanced and complicated
than just some little correlation that you might observe
this could be generally true but there's always going to be exceptions to it