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This is nothing but a steeper version of the short-run Phillips curve above. Inflation rises as unemployment falls, while this connection is stronger. That is, a low unemployment rate (less than U*) will be associated with a higher inflation rate in the long run than in the short run. This occurs because the actual higher-inflation situation ...
This exhibits a Phillips curve relationship, as inflation is positively related with output (i.e. inflation is negatively related with unemployment). However, and this is the point, the existence of a short-run Phillips curve does not make the central bank capable of exploiting this relationship in a systematic way.
Several studies around the Phillips curve tried to understand whether it is possible or not for policy makers to exploit the Phillips curve, that is to accept a lower level of employment, and so an higher level of unemployment, in exchange of inflation stabilisation. Nowadays there is a still of debate around this concept.
Milton Friedman argued that a natural rate of inflation followed from the Phillips curve.This showed wages tend to rise when unemployment is low. Friedman argued that inflation was the same as wage rises, and built his argument upon a widely believed idea, that a stable negative relation between inflation and unemployment existed. [11]
The Phillips curve appeared to reflect a clear, inverse relationship between inflation and output. The curve broke down in the 1970s as economies suffered simultaneous economic stagnation and inflation known as stagflation. The empirical implosion of the Phillips curve followed attacks mounted on theoretical grounds by Friedman and Edmund ...
One important application of the critique (independent of proposed microfoundations) is its implication that the historical negative correlation between inflation and unemployment, known as the Phillips curve, could break down if the monetary authorities attempted to exploit it.
Then, if workers and employers expect higher inflation, it results in higher inflation, as higher money wages are passed on to consumers as higher prices. This causes the short run Phillips curve to shift to the right and upward, worsening the trade-off between inflation and unemployment. At a given unemployment rate, inflation accelerates.
The New Keynesian Phillips curve was originally derived by Roberts in 1995, [48] and has since been used in most state-of-the-art New Keynesian DSGE models. [49] The new Keynesian Phillips curve says that this period's inflation depends on current output and the expectations of next period's inflation.