Answer to Question #98420 in Macroeconomics for Tiffany

Answer to Question #98420 in Macroeconomics for Tiffany


Question #98420

3. There is debate concerning both monetary and fiscal policy. You’ll examine each separately, then together.
d. The Phillips curve shows an important trade-off faced by economic policymakers. This trade-off was used to point out the legitimacy of government intervention in the economy for many years.
(i) What is the Phillips curve? What does it show? Why is it important to economic policymakers?

Expert’s answer

The dependence initially showed a connection between unemployment and changes in wages: the higher unemployment, the lower the increase in cash wages, the lower the increase in prices, and vice versa, the lower unemployment and higher employment, the greater the increase in cash wages, the higher the rate of price increase. Subsequently, it was transformed into a relationship between prices and unemployment. In the long run, according to Friedman, it is a vertical line, in other words, it shows the absence of a relationship between inflation and unemployment.The Phillips Curve is a graphical representation of the estimated feedback between inflation and unemployment. It was proposed in 1958 by the English economist William Phillips, who, based on empirical data for England for 1861-1957, deduced a correlation between the unemployment rate and the change in the growth of cash wages.Stagflation, which hit the economies of developed countries in the 1970s, discredited the idea of ​​the Phillips curve. Followers of Keynesianism, who shared the basic premises of this theory, were forced to admit that there is no clear inverse relationship between inflation and unemployment, and other options are possible.This belief system caused many governments to adopt a "stop-go" strategy where a target rate of inflation was established, and fiscal and monetary policies were used to expand or contract the economy to achieve the target rate. However, the stable trade-off between inflation and unemployment broke down in the 1970s with the rise of stagflation, calling into question the validity of the Phillips curve.

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