Phillips Curve and Natural rate of unemployment (Abridged)

บทความโดย วรรณพงษ์ ดุรงคเวโรจน์

As you known, the Phillips curve show the negative relationship between inflation and unemployment. There is trade off between two objectives of Macroenonomics. I will not show you about the besic idea about the conditions of Phillips cuve but I will begin with the problem of this relationship that Keynes can not explain.(also New Keynes or Neo-Keynes).

(from http://economicsonline.co.uk/Global_economics/Phillips_curve.html)
From the graph,
1. Initially, at point A, the unemplotment rate is 10 percent and the inflation rate is 0 percent.
2. This unemployment rate is the natural rate of unemployment and government and central bank attempt to reduce it through the expansionart policy (Fiscal and monetary policy).
3.Suppose the monetary policy is used. There are more money supple in circulation and contribute to an increase in price of goods and services and the employers want to expand their output by hiring the worker with higher wage that the demand for labour rise.
4. At that time, it's money illusion. Worker thought the increase in wage they are offered represent the real wage that they will get. They underestimate the inflation from higher price of goods and services. They did not realize that higher wage will be offsetted with the higher price of goods and services. (Actuallly, the real wage may be the same). However, they accept job.
5. So, the unemployment rate decline from 10 percent to 3 percent in Short run with the 2 percent inflation.
6. Eventually, when the time past,  workers realize that there is inflation. Their real wage decline from the consequences of inflation. So, they leave their job due to the higher price of goods and services.
7. The unemployment in turn back to 10 percent again with the inflation rate 2 percent.
8. Also, the government or central bank repeats this expansionary policy through the fiscal policy or monetary policy, the problem of unemployment is not solved. It stucks with the same rate of unemployment in long run. So, the phillips curve is the vertical line at 10 percent of unemployment rate in the long run.
9. The solution of this problem is either increase the job finding or reduce the job separation according to the formula of frictional unemployment.


Thank you :)