The Phillips curve has been a staple of economics for more than 50 years, but recently it no longer seems to be working. In fact, it appears to be dead.

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Ed Dolan’s Econ Blog
What Ever Happened
to the Phillips Curve?
May 12, 2014
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2. The Phillips Curve
 The Phillips curve is a graphical
representation of a supposed
tradeoff between inflation and
unemployment
 It is sometimes interpreted as a
menu along which an economy can
achieve a lower rate of
unemployment by tolerating higher
inflation, and vice-versa
May 12, 2014 Ed Dolan’s Econ Blog

3. The Original Phillips Curve
 The curve gets its name from the economist
A. W. H. “Bill” Phillips, the author of a 1958
paper that traced the relationship between
inflation and unemployment in Britain in the
19th and 20th centuries
 Although the fit was not exact, the British
data clearly showed an inverse relationship
between the two variables
May 12, 2014 Ed Dolan’s Econ Blog

4. The Phillips Curve in the Kennedy-Johnson Years
 The Phillips curve reached the
height of its popularity in the US
in the 1960s, after John F.
Kennedy was elected president
on a pledge to “get the country
moving again.”
 From 1961 to 1969, Kennedy and
his successor Lyndon Johnson
pursued expansionary policies to
meet that pledge
 The unemployment rate fell
steadily and inflation rose, as the
Phillips curve predicted
May 12, 2014 Ed Dolan’s Econ Blog

5. Early Criticism of the Phillips Curve
 Early critics noticed that after a few years,
the Phillips curve no longer worked well as
a policy menu. Additional inflation brought
almost no further drop in unemployment
 Milton Friedman, Edmund Phelps, and
others suggested a reason: As people
become used to higher inflation, the
Phillips curve shifts upward
May 12, 2014 Ed Dolan’s Econ Blog

6. The Shifting Phillips Curve Model (1)
 This figure shows a simplified
version of the Friedman-
Phelps shifting Phillips curve
model
 The model includes a vertical
long-run Phillips curve at the
economy’s natural rate of
unemployment
 The short-run Phillips curve
SRP shifts up or down along
the long-run curve as
conditions change
May 12, 2014 Ed Dolan’s Econ Blog

7. The Shifting Phillips Curve Model (2)
 The short-run Phillips curve
intersects the long-run
Phillips curve at the prevailing
expected inflation rate
 For example, SRP1
intersects the long-run curve
at an expected inflation rate
of 2 percent
 In this simplified version of
the model, each year’s
observed rate of inflation
becomes the next year’s
expected rate
May 12, 2014 Ed Dolan’s Econ Blog

8. Inflationary Dynamics in the Shifting Phillips Curve Model (1)
 Suppose we begin from point
A, where the observed and
expected rates of inflation are
both 2 percent and
unemployment is at its
natural rate, assumed here to
be 5 percent
 Next, expansionary policy
causes aggregate demand to
grow by enough to reduce
unemployment to 3 percent
 The economy moves up
along SRP1 and inflation
rises to 4 percent
May 12, 2014 Ed Dolan’s Econ Blog

9. Inflationary Dynamics in the Shifting Phillips Curve Model (2)
 In the next year, the expected
rate of inflation shifts the
short-run curve up to SRP2
 If fiscal and monetary policy
continue to be expansionary
enough to hold
unemployment at 3 percent,
the economy shifts up to
point C
 The observed rate of inflation
is now a worrisome 6 percent
May 12, 2014 Ed Dolan’s Econ Blog

10. Inflationary Dynamics in the Shifting Phillips Curve Model (3)
 Suppose now the
government tries to stop
inflation by applying
contractionary monetary or
fiscal policy
 Unfortunately, the short-run
curve has now shifted up to
SRP3
 As the economy moves from
C to D, unemployment rises
while inflation remains high
 This unpleasant combination
is sometimes known as
stagflation
May 12, 2014 Ed Dolan’s Econ Blog

11. Inflationary Dynamics in the Shifting Phillips Curve Model (4)
 If monetary and fiscal policy
remain tight, unemployment
will continue to increase
 However, since observed and
expected inflation are equal
at point D, this time the short-
run curve will not shift
 The economy ends up at E,
where unemployment is 7
percent and inflation is 4
percent
May 12, 2014 Ed Dolan’s Econ Blog

12. Inflationary Dynamics in the Shifting Phillips Curve Model (5)
 Now the observed rate of
inflation, 4 percent, is below
the expected rate of 6
percent, so the short-run
curve begins to shift down
again
 If tight policy continues, the
economy can move to F
 Inflation falls to 2 percent
without a further increase in
unemployment
May 12, 2014 Ed Dolan’s Econ Blog

13. Inflationary Dynamics in the Shifting Phillips Curve Model (6)
 The 2 percent inflation
observed at point F allows the
short-run curve to shift all the
way back to SRP1
 Finally, the government can
ease policy a bit and move the
economy back to its natural
level of unemployment at G
 If policy shifts to neutral, the
economy can stay in
equilibrium at G
May 12, 2014 Ed Dolan’s Econ Blog

14. The Stop-Go Cycle
 Over time, policymakers may
be subject to alternating
pressures first to “do
something” about excessive
unemployment and then “do
something” about excessive
inflation
 If that is the case, the
economy will trace out a
series of irregular clockwise
loops sometimes called
stop-go cycles
May 12, 2014 Ed Dolan’s Econ Blog

15. Stop-Go Cycles, 1961-1985
 In the years 1961 to 1985, the
US economy went through three
of these stop-go cycles
 The stop-go cycles seemed to
drift up over time, possibly
because governments were more
sensitive to pressures to reduce
unemployment than to pressures
to reduce inflation
 Also, the cycles drifted to the
right because the natural rate of
unemployment was rising
 These cycles seem to fit well with
the shifting Phillips curve model
May 12, 2014 Ed Dolan’s Econ Blog

16. The Great Moderation, 1986-2006
 After 1986, the pattern changes
 Stop-go cycles, if they can be
detected at all, become smaller and
more irregular
 The economy remains in a narrow
range around 2 percent inflation
and 5.5 percent unemployment,
which the Fed now officially treats
as its policy targets
 This period has come to be called
the Great Moderation
May 12, 2014 Ed Dolan’s Econ Blog

17. The Great Recession, 2007 to Present
 The Great Moderation ended with
the start of the Great Recession in
the fourth quarter of 2014
 This chart uses quarterly data for
inflation and unemployment during
the recession and the ongoing
recovery
 Inflation fell below zero for three
quarters in 2009
 By 2010, unemployment rose to
nearly 10 percent
May 12, 2014 Ed Dolan’s Econ Blog

18. Does the Phillips Curve Model Still Work?
 This chart compares the recoveries
from four recessions to see if the
shifting Phillips curve model still
applies
 A recovery is defined as the part of
the business cycle beginning when
GDP reaches its low point, or
trough, to the peak of GDP just
before the next recession begins
 Quarterly data are used for the
three recoveries of the 1960s and
1970s, and the recovery from the
Great Recession, which is still
incomplete
May 12, 2014 Ed Dolan’s Econ Blog

19. The Early Recoveries: Consistent with the Model
 The early recoveries all began with
a period in which unemployment
continued to rise while inflation
continued to fall
 As the recoveries continued,
inflation began to rise and
unemployment fell
 Between, there were brief periods
when unemployment began to fall
before inflation began to rise
 These patterns are consistent with
the shifting Phillips curve model
May 12, 2014 Ed Dolan’s Econ Blog

20. Recovery from the Great Recession: Not Consistent with the Model
 In contrast, the recovery from the
Great Recession has not been
consistent with the model
 It began with a period in which
inflation and unemployment both
rose while unemployment stayed
above the natural rate—a result
impossible to achieve in the shifting
Phillips curve model
 Since mid-2011, that has been
followed by a long period in which
inflation and unemployment have
both decreased
May 12, 2014 Ed Dolan’s Econ Blog

21. Recovery from the Great Recession: Inflation Expectations
 In the shifting Phillips curve model,
a period when inflation and
unemployment both fall, as they did
from mid-2011 to early 2014, can
only take place if inflation
expectations are falling
 However, data shown in the inset
chart indicate that inflation
expectations have been stable or
gently rising during this period
May 12, 2014 Ed Dolan’s Econ Blog

22. Conclusion: The Phillips Curve Seems to be Dead
Conclusions
 The shifting Phillips curve model
appeared to give a good explanation of
the 1960s and 1970s
 Because unemployment and inflation
changed little during the Great
Moderation, it is hard to tell if the model
was still working
 Events during the recovery from the
Great Recession seem to be
inconsistent with the model
 The Phillips curve now seems to be
dead, or if not, it is in a deep coma from
which it is not likely to awaken soon
May 12, 2014 Ed Dolan’s Econ Blog

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