[Joseph_E._Stiglitz,_Carl_E._Walsh]_Economics(Bookos.org) (1)

curve. A. W. Phillips was a New Zealander who taught economics in
England during the 1950s. He examined data from England on unemployment
and the rate of increases in nominal or money wages. He found
a negative relationship between the two, and this relationship is known
as the Phillips curve. At higher unemployment rates, money wages rose
more slowly. At lower unemployment rates, money wages rose more
quickly. The relationship he found is shown in Figure 37.2.
The logic behind the Phillips curve is straightforward. If unemployment
is low, firms have greater difficulty hiring workers. The result is
upward pressure on wages, as firms attempt to attract workers by paying
more. If unions and firms negotiate over wages, the union will be in a
stronger bargaining position, better able to get larger wage increases, if
labor markets are “tight.” At low unemployment rates, workers are more
likely to decide that the time is right to look for another job. Firms that
do not keep pace with wage increases elsewhere may discover that their
best workers are leaving. If workers believe that finding another job will
be easy, they may worry less about being fired. As a consequence, they may
not work as hard. To maintain worker productivity, firms will need to
raise wages more rapidly. In contrast, if unemployment is high, there will
be little upward pressure on real wages. Money wages will increase more
slowly or even decrease for some workers.
PERCENT CHANGE IN MONEY WAGES
10
8
6
4
2
0
Figure 37.2
Phillips
curve
1 2 3 4 5 6
UNEMPLOYMENT RATE (%)
THE ORIGINAL PHILLIPS CURVE
The Phillips curve shows that the rate of wage growth
rises as the unemployment rate falls. The curve shown
here is the one Phillips plotted in 1958 for the British
economy.
From Wages to Prices The Phillips curve relates unemployment to the rate at
which wages are changing. The bigger the imbalance between labor demand and
labor supply, the faster money wages will change.
The link between the rate at which wages are changing and the rate at which
prices are changing—the rate of inflation—is direct. Labor costs are, for most businesses,
the major component of their costs of production. In competitive markets,
prices will move in tandem with marginal costs, and an increase in wages will translate
directly into an increase in the marginal costs of production. Some firms, at
least in the short run, use a simple rule of thumb in setting prices—they set price
as a given markup over costs (e.g., 120 percent of costs). Under that system, changes
in the rate at which wages are changing will translate directly into changes in
the rate of inflation. Figure 37.3 shows the close historical relationship between
the two.
Because they move together, we can replace the rate of nominal wage increase
on the vertical axis of the Phillips curve with the rate of inflation. Even though Phillips
himself originally studied the behavior of unemployment and wages, it is more
common today to see Phillips curves that have the inflation rate on the vertical axis.
We will adopt this practice from now on when we use the Phillips curve.
The Phillips Curve and Cyclical Unemployment The relation between
inflation and unemployment that Phillips found for the United Kingdom also has
been found for other countries. Figure 37.4, which shows inflation and unemployment
for the United States during different periods, reveals an important fact. The
Phillips curve seems to shift. During periods of relative low inflation, such as 1960
to 1969 and 1984 to 2003, the inflation-unemployment relation is closer to the origin
SHORT-RUN INFLATION ADJUSTMENT ∂ 821