In this paper the author will discuss the relation of inflation and the Phillips curve. First, the concept and the different forms of inflation and their economical reasons will be explained. Afterwards the three prevalent models of the Phillips curve in literature are introduced and explained. The author will look into the theory of the NRU and NAIRU
and how they relate to the concept of the Phillips curve. In the last part of the paper, the applicability and validity of the Phillips curve for Germany is investigated more closely and the characteristics of the Phillips curve for Germany will be described. The Phillips curve originates of an empirical study of Arthur W. Phillips in 1958. There he describes the existence of a negative relationship between the rate of unemployment and the nominal wage growth in the UK between the years 1861-1957. The curve shows, that the higher the rate of unemployment, the lower the rate of wage inflation. His work represented a milestone in the development of macroeconomics.
Especially in the sixties and seventies, politicians in the USA and Europe thought they can interpret the relation of inflation and unemployment as a menu card of fiscal and monetary policy. A well-known quote by Helmut Schmidt, former chancellor of Germany in the 1970s, supports this thinking, when he said that an inflation rate of five percent is better than a five percent rate of unemployment. In the following years, a lot of different economist (Keynes, Samuelson, Friedman, Phelps, Lipsey et al.) modified the original curve and supported it with their customized theories. In this paper the author will discuss the relation of inflation and the Phillips curve. First, the concept and the different forms of inflation and their economical reasons will be explained. Afterwards the three prevalent models of the Phillips curve in literature are introduced and explained. The author will look into the theory of the NRU and NAIRU and how they relate to the concept of the Phillips curve. In the last part of the paper, the applicability and validity of the Phillips curve for Germany is investigated more closely and the characteristics of the Phillips curve for Germany will be described.
Table of Contents
1 Introduction
2 Inflation and the Phillips Curve
2.1 Inflation
2.1.1 What is Inflation?
2.1.2 Types of Inflation
2.1.3 Cause of Inflation
2.1.4 Problems of Inflation
2.2 The Phillips Curve
2.2.1 The original Phillips Curve
2.2.2 Modified Phillips Curve
2.2.3 Expectations-augmented Phillips Curve
2.2.4 Altering of the Phillips Curve by Exogenous Shocks
2.2.5 Phillips Curve Loops
2.2.6 NAIRU and NRU
3 The empirical Phillips Curve for Germany
4 Summary
Research Objectives and Key Topics
This paper examines the relationship between inflation and unemployment through the lens of the Phillips curve. The primary research objective is to analyze the evolution of this economic concept, evaluate its theoretical validity, and investigate its practical applicability in the context of the German economy from the 1960s to the early 2000s.
- Theoretical foundations of inflation and its various causes.
- Development and modification of the Phillips curve models (Original, Modified, and Expectations-augmented).
- Analysis of the NAIRU (Non-Accelerating Inflation Rate of Unemployment) and its implications for monetary policy.
- Empirical evaluation of Phillips curve patterns and labor market dynamics in Germany.
- Discussion of structural unemployment and the impact of labor market reforms.
Excerpt from the Book
2.1.1 What is Inflation?
Inflation measures the annual rate of change of the general price level in the economy manifesting in a sustained increase in the average price level. When the general price level increases, the purchasing power of the consumer will drop - the money loses value. This is different from a rise and fall in the price of a particular good or service. Individual prices rise and fall all the time in a market economy, reflecting consumer choices or preferences and changing costs. Inflation occurs when most prices are rising by some degree across the whole economy.
Inflation is an ongoing process and results either from an increase in aggregated demand (demand-pull inflation) or from a decrease in aggregated supply (cost-push inflation). The inflation is calculated based on price indices. In Germany the inflation is calculated based on the Consumer Price Index (CPI). There a basket consisting of 750 different goods and services is compared with the same basked from the reference year which represents the basis for calculation. The inflation rate for Germany from 2000 up to 2006 is illustrated in Figure 6 in the Appendix. It can be seen that the CPI is increasing since 2000 which means that the consumers now have to pay more for the same amount of goods compared to the year 2000. The real purchasing power of the consumer steadily decreased, so there has been inflation. However, it can be seen that inflation in Germany shows a downward tendency since mid 2005 until now.
Summary of Chapters
1 Introduction: This chapter introduces the historical context of Arthur W. Phillips' 1958 study and outlines the paper's aim to analyze the evolution and validity of the Phillips curve.
2 Inflation and the Phillips Curve: This section details the concepts of inflation, examines the three primary models of the Phillips curve, and discusses the role of expectations, supply shocks, and the NAIRU.
3 The empirical Phillips Curve for Germany: This chapter applies the theoretical frameworks to the German labor market, evaluating historical data, structural unemployment, and the limitations of demand-driven policy.
4 Summary: The concluding chapter synthesizes the findings, noting that the Phillips curve is best understood as a short-run tool and is insufficient as a standalone policy menu in modern economies.
Keywords
Inflation, Unemployment, Phillips Curve, NAIRU, NRU, Aggregate Demand, Aggregate Supply, Stagflation, Monetary Policy, Labor Market, Germany, Rational Expectations, Adaptive Expectations, Structural Unemployment, Economic Growth.
Frequently Asked Questions
What is the primary focus of this paper?
The paper explores the relationship between inflation and unemployment, tracing the development of the Phillips curve from its empirical origins to its modern application in economic theory.
What are the core themes addressed?
Central themes include the mechanisms of inflation, the shift from original to expectations-augmented Phillips curves, the structural determinants of unemployment, and the challenges faced by policymakers.
What is the main research question?
The work investigates whether the trade-off between inflation and unemployment, as suggested by the Phillips curve, remains a valid and reliable tool for steering economic policy in modern industrialized nations like Germany.
Which scientific methodology is employed?
The author uses a literature-based theoretical analysis combined with an empirical examination of historical data, specifically focusing on the German economy between 1961 and 2003.
What topics are covered in the main section?
The main part covers the definition and causes of inflation, the three prevalent Phillips curve models, the concept of NAIRU, and the specific empirical performance of these theories in the German labor market.
Which keywords best characterize this work?
Key terms include Inflation, Phillips Curve, NAIRU, Structural Unemployment, and Labor Market Reform.
How did the 1970s influence the validity of the Phillips curve?
The emergence of stagflation in the 1970s, where both inflation and unemployment rose simultaneously, contradicted the traditional Phillips curve trade-off, leading to the development of the expectations-augmented model.
Why is the NAIRU considered an absolute limit for monetary policy?
Because the NAIRU is driven by structural and institutional factors, attempting to lower unemployment below this rate using monetary expansion only results in accelerating inflation without achieving sustainable employment gains.
- Quote paper
- Thomas Vogt (Author), 2007, Inflation and the Phillips curve, Munich, GRIN Verlag, https://www.grin.com/document/91893
