Phillips curve | Inflation – measuring the cost of living | Macroeconomics | Khan Academy
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Phillips curve | Inflation – measuring the cost of living | Macroeconomics | Khan Academy

In the late 1950s, William Phillips noticed a correlation between unemployment and inflation and I have a picture of this gentleman right over here, Irving Fisher because he actually noticed that relationship a few decades before but the relationship has taken on Phillips’s name really because his publication kind of captured people’s imagination and the relationship is not that surprising it seems to fall a little bit out of common sense but we’ll talk about examples that seem to go against this relationship If I were to plot the unemployment percentage right here on my horizontal axis and I plot inflation on my vertical axis, so let me put inflation here Then he noticed, (and I’m just gonna pick random data points) but in one year where there was high inflation, there was low unemployment and then in another year, where there was high unemployment, there was low inflation and it’s not clear which one’s causing which or maybe they both circle back on each other and then in other years, maybe where you had medium inflation or relatively low unemployment so he looked at a bunch of years and plotted them on an axis like this (let me do them all in the same color) so you take a bunch of years and you plot them here so now you have higher inflation, slightly higher unemployment than that year over there and I could just keep plotting some points over here you could have deflation and what he saw is that there’s a correlation here that there’s an inverse relationship that if you were trying to fit a curve to these points and you could have more points here, I’m just picking them at random, you could fit a curve that looks something like this generally saying, when you have high inflation, so when you’re up here, you have high inflation and low unemployment the low unemployment part is a good thing and now here you have low inflation and high unemployment and if this curve goes below the horizontal axis you would actually have deflation and it makes reasonable sense we’ve kind of talked bout it in common sense terms before but you can imagine – once again, it’s not clear which one’s causing which – but you can imagine a world, just reasoning through it, that if you have low unemployment, or you could view that as high employment, one way to view low unemployment is that you have a high utilisation of the labour market well, now, in this situation, workers have more leverage and if workers have more leverage then employers will have to increase wages to attract and retain employees they have more leverage and they have more options there are a lot of people looking to hire them employers raise wages to attract and retain employees but of course when you increase wages you’re increasing buying power, generally for workers so this is increasing workers’ buying power which would increase their demand for goods and services and if they’re increasing the demand for goods and services, they’re going to increase the utilisation of all of the factors of production: of land, of capital, of entrepreneurship, and of labour, so that’s going to lower unemployment even more and you can imagine if you already have low unemployment, and this is just one of the factors of production, but if you think about all factors of productions, they are probably all highly utilised the factories are running at close to full capacity the labour market is running at full capacity if you increase buying power, if you increase demand in that context, so demand is going up lower unemployment, labour utilisation is going down there’s less capacity, more demand this is going to cause prices to go up so this is going to cause prices generally to go up and then if prices go up, now workers have leverage and options of employment but they also have higher cost higher cost of living and this is a very kind of hand, wavy diagram, but it’s just to make you think about the overall dynamics so workers have more options and leverage they also have a higher cost of living, the whole economy is kind of operating at close to full tilt and so they’re going to demand higher wages even more and then this thing can keep cycling and keep cycling now, this seems a bit common sense, but there are exceptions to these in the 1970s, the US experienced stagflation and that’s kind of the worst: that’s high inflation and high unemployment so that is right over here and things that could cause it and particularly what people point to in the 1970s, and it’s always important to realise that in economics people don’t know for sure what was the exact cause and there seldom is only one cause but one of the things that’s often pointed to is that you had a supply shock and the supply shock was in oil it made the cost of producing everything more expensive and so that just drove the prices up but really didn’t allow the country as a whole to become more productive one way to think about it is it drove the prices up here causing a higher cost of living right over here but this part of this cycle that we associate with low unemployment and high inflation was not occurring and because those higher prices were essentially going out of the country, you could essentially imagine that they were squeezing out people’s ability to pay for other things so the higher cost of living or the higher prices for oil you could draw a line from either one and I know it’s getting messy now you can imagine that it inhibited demand for domestic production so I’ll draw “negative feedback” right over there so it squeezed out people’s desire to buy things because they had to pay so much for oil and there’s other explanations for it when people saw the low unemployment, the government wanted to print even more money to fuel things, but it did not get this virtual cycle happening there were some arguments that there were structural reasons why the economy couldn’t adapt properly so that employees and resources couldn’t be allocated efficiently but the whole point of bringing up the 1970s is to show you that this isn’t a law it’s not clear what’s causing what that there was a situation in the 1970s where you had stagflation and the opposite of that was what we really saw in the late 90s where you had relatively low inflation and you had relatively low unemployment so this is a very good situation that we had in the late 90s and the argument that many people make why we were able to do that, why this cycle didn’t keep going on and on why the prices didn’t go up is that you had this other trend of huge technological improvement you had computers, and telecommunications, the Internet, this kind of super productivity curve so even though you had the cycle, you had increased buying power, demand was going up, the proactivity of the country was increasing so much that it did not lead to inflation so that’s what threw us there in the late 90s so, in general, it’s a neat thing to think about, at least to some degree it seems like common sense, but like in all things in economics, it’s always a little bit more nuanced and complicated than just some little correlation that you might observe this could be generally true but there’s always going to be exceptions to it

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66 thoughts on “Phillips curve | Inflation – measuring the cost of living | Macroeconomics | Khan Academy

  1. The Philips Curve has been discredited many times now so it's scary that people still believe in it. Of course, central banks and politicians love it because they get to print money out of thin air and spend it. sigh

  2. WRONG! Wages can't rise without can expansion of the money supply. Wages(the price of labor), like any other price, cannot rise because it is constrained by the amount of money that exists. Inflation just lowers real wages, as nominal wages stay the same with higher prices, and therefore it is the low wages that create higher employment.

  3. First of all the Phillips curve has been debunked. Secondly, in the 1970s Nixon severed the link between gold and the dollar and ever since the dollar has depreciated along with every currency linked to it. Thirdly, the increase in economic capital and general productivity improvements naturally lower costs of production over time. If the currency is not debased, as in the 2nd half of the 1800s, general growth and good deflation occur improving everyone's wealth.

  4. @RyogaShark,
    "Higher employment is what causes Wages to rise."
    No, it's higher demand for labor, not higher employment. You can still have raising wages with high unemployment, especially under artificial wage floors.

  5. Inflation is the expansion of the money supply. To inflate is to expand the money supply. Rising prices are the consequence of inflation. Prices don't inflate, they rise or fall. The supply of money inflates or deflates. When the Fed creates trillions of dollars out of thin air you have more dollars chasing the same finite amount of goods and services. Prices fell during the industrial revolution.

  6. @RyogaShark,
    Not necessarily "higher employment". If you have price floors on labor, you can have high demand and still high unemployment.

    The problem with Keynesian economics is that Keynesians tend to lump people's economic decisions into simplistic categories. For instance, they would lump together all employment and all wages to determine an average wage, when in fact people work in very diverse and different fields, with different productivity outputs.

  7. If expansions in the money supply (inflation) inevitably cause price increases, then why has the central bank of Japan's trillion+ injection into the financial system not caused run-away price increases? In fact, deflation and anemic inflation have remained persistent and this has plagued Japan's economy for over 2 decades.

  8. Because demand has to increase in response to the rise in the monetary base. Paul Krugman is probably the guy to read on Japan's lost decade.

  9. Once the federal reserve raises interest rates or the government has to pay its debts the economy will just go back into recession

  10. I don't think you should have ended this lesson by simply stating that the Phillips Curve "could be generally true". If that were true there would not be a second version of the curve which is the one generally accepted nowadays. The modified version of the curve takes into account inflation expectations of the economic agents and a "natural" rate of unemployment. In short, the agents realize what's going on and the effect eventually fades away, bringing unemployment back to the natural rate.

  11. whats wrong with that ? it has not caused inflation here in uk – printing money has little impact on inflation
    its a media overeaction

  12. wat do the feds do with printing money! buy bonds hope banks lend?
    has it happened ? no – has inflation gone up ? no
    in theory it should raise inflation but its not happened

  13. We are not seeing inflation for the simple reason that demand for goods has not gone up. All the Fed is doing is circulating the money in the financial sectors. The idea was for the money the Fed gave to the financial sectors to make its way back into the U.S. Economy. Has that happened? I do not think so but you can be the judge.

  14. Printing money is inflation and it is important for economies to be inflating. When you speak of inflation most people think that it is some terrible thing like Zimbabwe, but it is not. That was a case of hyperinflation or runaway inflation. Here in the U.S. the goal is about 2% inflation per year.

  15. If you have no demand for goods you see deflation which can be worse, if you have products nobody wants you have to keep lowering prices to the point where you gain nothing selling them. Inflation helps drive demand of goods. The problem is the Fed Reserve is trying to spur demand in our economy by endlessly printing money. They are inflating away wealth in some cases. Putting my money in the bank I earn 0.1% interest on that money. Inflation target is 2%. My money is being inflated away.

  16. Or I can risk my money gambling in the stock market. We all know that is a rigged game and unless you know the house rules stay away.

  17. Central Banks and Politicians "love it" because it is true in the short run usually.

    The Philips Curve is very useful.

  18. If you have products that people aren't buying then deflation is an important signal telling you to stop wasting resources on products that nobody wants.

  19. On the flip side we should see deflation when technological advances allow for better products to be made more efficiently and therefore more cheaply. In my mind both inflation and deflation are needed to keep an economy stable.

  20. The result has been inflation in the stock market and real estate. Just like what happened in the run-up to the Great Recession.

  21. Not necessarily true. If employment causes inflation (which should be intuitively obvious) but isn't the only cause then in a low employment situation the other causes of inflation could still overcompensate for the low employment. In the early 70's, for example, Nixon took us off the gold standard which made it easy for the FED to increase the money supply, which can cause inflation.

  22. While I'm very sympathetic to the Austrian school it should be obvious that without demand for consumer goods there would be no economy. No one would create surplus if there wasn't any demand for that surplus. Even if someone makes a product that no one wants all he's accomplished is to waste resources.

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  24. It's well explained but I think it still lacks of information. How about the New Keynesian Philips Curve, New Classical version, and how the formula is..

  25. SAL … can u relate it to NAIRU( NON ACCELERATED INFLATION RATE OF UNEMPLOYMENT). i find it mentioned in many books but cant comprehend it from there ….thanks

  26. Im just wondering…does this man know everything? He's helped me with series for AP calc bc and ap physics before, and macro too?!

  27. Holy shit Khan Academy needs to get someone else to voice their videos. This guy is the fucking worst

  28. I have huge confusion about this… I think there is inverse relationship between money wage and unemployment or inverse relationship between money supply and unemployment.

  29. Very nice explanation of what the philips curve is. However data does not support this in the US. Correlation between between unemployment rate and wage rise is less than 0.1%. Other data explains wage rise better.

  30. inflation stimulated the economy because the base of an economy is to reproduce itself, when you have high inflation it means the means of production move into the hands of those doing it more efficiently, because inflation does not actually effect those producing goods as they simply obtain more money relative to the value they are producing. high inflation stimulates spending as saving's become diminished and so anybody with money uses it to reproduce what really money is a measurement- the goods produced. with low inflation i could produce lots of goods one year and live happily for the rest of my life, with inflation it means i must keep producing. one of the reasons removing the gold standard is actually beneficial.

  31. Late 90s had super low oil prices and more cheap labor from China, both causing low inflation. In my view the Phillips curve only applies for products made within the country considered. For example, low unemployment in the healthcare industry has been causing health care costs to increase. Same for college education (high demand, low supply). Foreign-made products that use foreign labor (where unemployment is high and wages $1 per hour) will experience low inflation when imported to the u.s. and confuse the u.s. economists at the fed. Only when the dollar falls and/or oil prices rise, will we have more widespread inflation in the u.s.. Luckily for now, fracking oil locally has saved us from oil price inflation.

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