Background
The Expectations-Augmented Phillips Curve is an evolution of the traditional Phillips Curve, which relates wage increases and unemployment rates. The modification incorporates anticipated inflation rates into the relationship, reflecting how expectations of future inflation impact current economic dynamics.
Historical Context
In the late 1950s and 1960s, the original Phillips Curve, developed by economist A.W. Phillips, demonstrated a stable, inverse relationship between unemployment and wage inflation (and by extension, price inflation). Economists later recognized that this relationship did not hold over longer periods, especially in the face of changing expectations about inflation.
Definitions and Concepts
The Expectations-Augmented Phillips Curve posits:
- Unemployment Rate: As the unemployment rate declines, wage increases tend to rise.
- Expected Inflation Rate: When workers and businesses expect higher future inflation, they adjust their behavior, leading to higher wage demands and price settings.
- Demand Pressure: Economic demand impacts wage hikes and price inflation.
Given these premises, if demand pressure elevates the actual rate of inflation, expected inflation will subsequently rise, moving the original Phillips Curve upward.
Major Analytical Frameworks
Classical Economics
Classical economists did not generally incorporate expectations explicitly into their models but recognized that sustained inflation often results from continued increases in the money supply.
Neoclassical Economics
Neoclassical economics allows for the Expectations-Augmented Phillips Curve in understanding that rational expectations of agents within the market affect wage and price settings.
Keynesian Economics
Keynesian models, especially New Keynesian economics, place a significant emphasis on how expectations influence economic behavior and wage-price spirals, integrating the expectations-augmented concept.
Marxian Economics
Though less directly focused on the Phillips Curve, Marxian economics situates discussions of wages and employment within broader class struggles, where expectations might change with class-consciousness and labor-capital dynamics.
Institutional Economics
Institutional economics would consider the expectation of inflation as shaped by regulatory and institutional frameworks that guide individual and collective behavior in the economy.
Behavioral Economics
Behavioral economics would explain the adjustments due to expected inflation by investigating psychological and cognitive biases influencing inflation expectations.
Post-Keynesian Economics
Post-Keynesians might approach the expectations-augmented model with suspicion, questioning the stability of inflation and unemployment relationships and emphasizing the role of institutional action.
Austrian Economics
Austrian economists view discussions of wage rates and employment through the lens of market dynamics and inflationary policies of central banks, with expected inflation playing a vital role in decision-making.
Development Economics
The model would be crucial in mapping the evolving labor markets in developing nations where inflation expectations might be influenced by rapid developmental changes.
Monetarism
Monetarists often consider the Expectations-Augmented Phillips Curve in their evaluation of inflation control, stressing the role of stable money supply to manage expectations.
Comparative Analysis
The Expectations-Augmented Phillips Curve highlights the feedback loop between actual and expected inflation, contrasting with the more static interpretation of the original Phillips Curve. This dynamic analysis is pivotal in modern economic policies’ design for controlling inflation and unemployment.
Case Studies
Case studies prominently using the Expectations-Augmented Phillips Curve include the stagflation periods of the 1970s in Western economies, where rising inflation expectations decoupled the previously stable Phillips Curve relationships.
Suggested Books for Further Studies
- “Inflation and Unemployment: Theory, Experience and Policy Making” by Victor E. Li
- “Expectations in Economics” by George W. Evans and Seppo Honkapohja
Related Terms with Definitions
- Phillips Curve: A graphical representation- showing an inverse relationship between rates of unemployment and corresponding rates of inflation.
- Inflation: The rate at which the general level of prices for goods and services is rising.
- Non-Accelerating Inflation Rate of Unemployment (NAIRU): The specific level of unemployment that exists when the inflation rate is stable.
- Hyperinflation: Extremely high and typically accelerating inflation, often leading to the collapse of a country’s monetary system.