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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.
The Phillips curve equation can be derived from the (short-run) Lucas aggregate supply function. The Lucas approach is very different from that of the traditional view. Instead of starting with empirical data, he started with a classical economic model following very simple economic principles. Start with the aggregate supply function:
In 2002, Mankiw and Ricardo Reis proposed an alternative to the widely-used New Keynesian Phillips curve that is based on the slow diffusion of information among the population of price setters. Their sticky-information model displays three related properties that are more consistent with accepted views about the effects of monetary policy.
Greg Mankiw maintains the IS/MP model has "quirky features". Mankiw prefers the IS–LM model, for, according to him, it focuses on "important connections between the money supply, interest rates, and economic activity, whereas the IS/MP model leaves some of that in the background".
Adaptive expectations were instrumental in the consumption function (1957) and Phillips curve outlined by Milton Friedman. Friedman suggests that workers form adaptive expectations of the inflation rate, the government can easily surprise them through unexpected monetary policy changes.
This modification, however, had a significant effect on Friedman's own approach, so, as a result, the theory of the Friedmanian Phillips curve also changed. [113] Moreover, new classical adherent Neil Wallace , who was a graduate student at the University of Chicago between 1960 and 1963, regarded Friedman's theoretical courses as a mess ...
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.
It combines aspects of the Harrod–Domar growth model with the Phillips curve to generate endogenous cycles in economic activity (output, unemployment and wages) unlike most modern macroeconomic models in which movements in economic aggregates are driven by exogenously assumed shocks. Since Goodwin's publication in 1967, the model has been ...