Most economists in the United States have noticed that inflation statistics and behavior has been unpredictable compared to the past. Predictions used to correlate unemployment with inflation in the past decades have been unstable and challenging the existing models. A model referred to as the Phillips’s Curve has been for years to study and predict the behavior of inflation.
What is the Phillips Curve?
The Phillips Curve is a known statistical relationship of the labor market and the estimated rate of inflation. It involves other determinant factors, such as oil prices, exchange rates, and inflation statistics. The theory states that when times are good economically, the population will have a few unemployed workers, variables that push a rise in the cost of living and wages. The financial specialist, William Phillips, proposed the Phillips Curve after observing that wages increased when the United Kingdom experienced a low unemployment rate. Governments to influence or stabilize inflation have used the Curve routinely.
What Events Led to the Doubting of the Phillips Curve?
The Phillips Curve has been doubted several times in the past sixty years, especially in the renowned global crisis. Financial experts observed that the shape and solidity of the Phillips flattened or collapsed during the 2007-2009 financial crisis and onwards. In the US, a sharp increase in unemployment was seen in 2009 with no further fall of inflation as predicted by the Phillips Curve.
What the Central Bank Targets?
Typically, central bankers and economists used the Phillips Curve to maintain inflation within desired limits and employment rates. According to the model, high employment rates result in stagnating wages and overall spending. In this light, inflation experiences a downward pressure that forces financial policymakers to reduce interest rates. The reverse is true. Hence central bankers and most nations target an average rating in inflation and unemployment. For instance, a 2% inflation rate guarantees confidence in the nation’s currency, employment rate satisfaction, and balance between employers and employees.
What has Changed?
Unlike the past, where the Phillips Curve was expected to shift down or up, currently, it has been observed to move in rotation. Interestingly, unemployment seems to have little or no effect on the Phillips Curve. It has been proposed that the observation might be due to the mistranslation of the unemployment rate and the amount of spare capacity an economy has. Some nations, such as Japan and the US, have considered hiring groups that previously fall outside the unemployment bracket, such as women and retired individuals.
Inflation has been observed to stagnating or rise gradually, although there is a continuous boom of jobs. Firms have avoided reducing wages because it will adversely affect the staff morale of an individual. Some scholars believe the Phillips Curve is correct and active at the local level, but it’s hibernating at the national level.
Policymakers and bankers could be the reason why the Phillips Curve remains flat in the US. One of the functions of the central banks is to strike a balance between inflation and unemployment by tilting the Curve in the opposite direction. For instance, when inflation is expected to rise, central banks devise and implement policies that guarantee a slight increase in unemployment. The reverse is true. Furthermore, central banks face challenges in lowering interest rates below specific standards, resulting in detrimental effects. High-interest rates, especially during tough economic times (the pandemic), have contributed to the changes in the Phillips Curve.
Governments should employ modern solutions to address the changes observed recently relating to inflation and unemployment. Policymakers and governments should adopt new and ingenious ways to study this relationship and prevent adverse effects on the economy.