Unemployment, NAIRU and The Phillips Curve

http://www.bized.ac.
uk
Unemployment,
NAIRU and
the Phillips Curve
Copyright 2006 – Biz/ed

http://www.bized.ac.uk
Unemployment, NAIRU and the

Phillips Curve

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

• 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
As the coal industry declined, many miners had difficulties
utilising their skills to find work in new industries such as IT
and service sector work. An example of structural change in
the economy leading to unemployment.
Title: On Duty. Copyright: Getty Images,
available from Education Image Gallery

• Seasonal
Unemployment:
• Unemployment
caused because of
the seasonal
nature of
employment –
The demand for lifeguard services tends to exist
in the summer but nothing like as much in the tourism, skiing,
winter – an example of seasonal
unemployment. cricketers, beach
Copyright: Swiassmautz, http://www.sxc.hu lifeguards, etc.

• 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
A fall in aggregate demand can lead to a decline in
primarily a lack of
spending forcing businesses across the economy into demand in the economy
closing with damaging effects on employment as a
result.
which could be
Copyright: Beeline, http://www.sxc.hu influenced by the
government

• Technological
Unemployment:
• Unemployment
caused when
developments in
technology replace
human effort – e.g in
manufacturing,
administration etc.
Look: No workers! Robots rule where humans once stood!
Titles: Assembly Line Workers, Electronic Factory. Copyright: Getty Images, available from Education
Image Gallery

Unemployment

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’

Unemployment
• Keynesian
Unemployment:
• Unemployment in the
long run may remain
stubbornly high because
of imperfections in the
market – ‘sticky wages’
Widespread unemployment in some parts of the UK during the 1930s seemed to contradict the
assumptions made by classical economists. Post 1945, Keynesian demand management
put full employment through government intervention in the economy as a policy priority.
Title: Poverty in Wigan. Copyright Getty Images, available from Education Image Gallery

Inflation

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.
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

Inflation and Unemployment using AS/AD

AS2 AS1
Inflation TheTheshort
riserun
in the
AD
fall economy
leads
in unemployment
to ahas
fall an
in inflation
is only
Assume
temporary;
unemployment
rate of as2%AS but
shifts,
a inflationary
unemployment
and 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
runtoinexpand
aforposition
output
withbut at
4%. AD rises some reason.
unemployment
increased cost at –4%employing
but with more
higher
inflation.
expensive Expansionary
capital, paying fiscalworkers
or monetary
more
policy
to dowillwork
onlyetc.
lead Increased
to reductions
cost results
in in
unemployment
a shift in AS to in the
the left
short– workers
run. In thestart
long
to
4.0% runbeunemployment
laid off. will return to its natural
rate. Attempts to reduce unemployment
below the natural rate will be inflationary.
3.75%
2%
AD2
AD1
U = 4% U = 3%
Real National Income

The Philips Curve

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

Wage growth %
(Inflation)
The Phillips Curve
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% Unemployment (%)
PC1

The Phillips Curve

• Problems:
• 1970s – Inflation
and unemployment rising
at the same time – stagflation
• Phillips Curve redundant?
• Or was it moving?

Wage growth %
(Inflation)
The Phillips Curve
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
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 aof
once
cost
again
1% of
but
injects
higher
very resources
high
inflation.
unemployment
Individuals
into the economy
at
now7%.base
– the
their
result is
wage
a Government
short-term
negotiations
fall
takes
in unemployment
onmeasures
expectations
to reduce
but
of higher inflation
inflation.
inunemployment
This
thehigher
next period.
inflation
byIfan
fuels
higher
expansionary
further
wagesexpectation
arefiscal
granted
policy
ofthen
higher
firms
inflation
that costs
pushes
andrise
so
AD–the to
they
process
thestart
rightto
continues.
(see
shedthe
labour
AD/AS
Theand
long run
unemployment
Phillips
diagram Curve
on slide
iscreeps
vertical
15) backat the
upnatural
to 7% again.
rate of
unemployment. This is how economists have explained
3.0% the movements in the Phillips Curve and it is termed
the Expectations Augmented Phillips Curve.
2.0%
1.0%
PC1
7% PC2 Unemployment
PC3

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)

The Phillips Curve

• To reduce unemployment
to below the natural rate
would necessitate:
• Influencing expectations –
persuading individuals that inflation
was going to fall
• Boosting the supply side of the
economy - increase capacity
(pushing the PC curve outwards)

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

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. Messengers leaving the Bank of England with news of a change in interest rates in 1967
during the sterling crisis.
Title: Bank Messengers. Copyright: Getty Images, available from Education Image Gallery

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http://www.bized.ac.

Copyright 2006 – Biz/ed