20) evaluating phillips curve arguments

Question 1

why do neo-classical believe there is a difference between SRPC and LRPC?

Answer 1

Belief in the concepts of NRU and NAIRU convince neo-classical economists that there is a difference between the Short-run Phillips Curve (SPRC) and the Long- run Phillips Curve (LRPC).

Question 2

how is SRPC linked to the Keynesian model?

Answer 2

In essence, the SPCis the same trade-off as the traditional Phillips Curve. It suggests that you can reduce unemployment in the short run but by doing so you will increase the rate of inflation. More importantly, it also suggests that there is really no point in doing this. Unemployment is natural and will always revert to its natural level (NAIRU) in the long run.

Question 3

when does NRU shift?

Answer 3

can shift right (i.e., get higher due to changes in technology such as Al) or it can shift left (get lower) e.g., due to changes in the benefit system of a country. The point is though that long-term changes in NRU/LRPC are brought about by changes in other factors, not changes in the Price Level/Inflation.

• supply side policies shift left, not dependant on AD, Neo-classicals don’t believe in Fiscal or Monetary

Question 4

why is the phillips curve useful?

Answer 4

1. Keynesian economists believe that governments can use the Phillips Curve evidence to achieve long term reductions in demand-deficient or cyclical unemployment (eg by expansionary Fiscal Policy) This could permanently reduce unemployment albeit with some inflation
2. Neo-Classical economists disagree and use the Phillips Curve as evidence to argue against expansionary fiscal policies. They believe that any reduction in unemployment will only be temporary in the long run, unemployment will always revert back to NRU. There is no point in trying to reduce unemployment rates as the only long-term consequence is to increase the price level

Question 5

phillips curve criticisms:

Answer 5

1. The original PC was proven to be flawed by the emergence of stagflation in the 1970s
2. The Neo-Classical LRPC fails to consider the long term effects of high inflation in the labour market and the fact that it may well shift NRU to the right as increased uncertainty that inhibits business activity in the long term.
   - inflationary expectation demolishes key plank of Neoclassical, the LRPC maybe should be more horizontal

((3)) The Neo-classicals (no sticky prices) fail to explain the long term success of expansionary fiscal policies such as the New Deal and Marshall plans (rebuilding Western Europe) where economies are significantly under-capacity. Here the Keynesian argument works better, you can shift AD to the right, reducing unemployment in the LR without creating inflation

Question 6

which school is more accurate for the PC?

Answer 6

Ultimately, it is likely that there exists some relationship between unemployment rates and inflation rates.
inflation. Both views of the Phillips curve provide some guidance for economic policy makers. The Neo-Classical idea of the SRPC shifting position depending on inflation rates is more likely to be correct than the Keynesian static PC.
If inflation occurs levels of unemployment will adapt to the new price levels. If inflation is increasing the SRPC will shift right; if inflation is decreasing SRPC will shift left.

Question 7

what are there debates on?

Answer 7

Even then, there are debates about how steep the Phillips Curve will be. In other words: how strong is the link between the 2 variables? A steeper SRPC shows a strong inverse relationship whilst a flatter PC shows a much weaker link between the 2 variables. The steepness and positioning of the SPC is a factor used bu central banks in determining interest rate changes.

Question 8

what is the arguement for NAIRU and LRPC

Answer 8

However, the neo-classical vision of the fixed LRPC at NAIRU is much more open to debate. For example:
Where is NRU? According to the Federal Reserve “No one knows for certain what the actual “natural rate of unemployment” is; it is not observable. Secondly is the LRPC actually vertical or is it a different shape?
Criticism 2 above suggests it could be be vertical then upward sloping right. However, it could be that the LRPC is negatively sloped i.e. that long term low rates of inflation contribute to a lower NRU due to improvements in business and investor confidence and the business environment.

Question 9

In conclusion…

Answer 9

In conclusion, it depends! Who do you believe? How long is the long term? How high is high inflation? How reliable is the inflation/unemployment data? Can the government make the correct use of the data?