Question

INFLATION AND THE PHILLIPS CURVE

explain with your own words

1 What is the Phillips curve?

2 What is the relationship between inflation and growth?

Answer 1

Ans. 1. Phillips Curve is a an economic concept developed by A. W. Phillips stating that inflation and unemployment have a stable and inverse relationship. The theory claims that with economic growth comes inflation, which in turn should lead to mopre jobs and less unemployment. However, the original concept has been somewhat disproven empiricaliy due to the occurrence of stagflation in the 1970s, when there were high levels of both inflation and unemplyment. Key takeaways are : 1. The Phillips curve states that inflation and unemployment have an inverss relationship. Higher inflation is associated with lower unemployment and vice versa.      2. The Phillips curve was a concept used to guide macroeconomic policy in the 20th century, but was called into question by the stagflation of the 1970's          3. Understanding the Phillips curve in light of consumer and worker expectations, shows that the relationship between inflation and unemployment may not hold in the long run,or even potentially in the short run.      However, the implications of Phillips curve have been found to be true only in the short term. Phillips curce fails to justfy the situation of stagflation, when both    inflation and unemployment are alarmingly high. What is the relationship between inflation and economic growth? If economic growth is caused by aggregate demand increasing faster than productive capacity- if economic growth is above the 'long-run trend rate' then economic growth is likely to cause inflation. Like many countries, industrialised and developing, one of the most fundanental objectives of macroeconomics policies in Fiji is to sustain high economic growth with low inflation. However, there has been considerable debate on the nature of the inflation and growth relationship. Macroeconomists, central bankers and policymakers have often emphasised the costs associated with high and variable inflation. Inflation imposes negative externalities on the economy when it interferes with an economy's efficiency. Inflation can lead to uncertainty about the future profitability of investment projects. This lead to more conservative investment strategies than would otherwise be the case, ultimately leading to lower levels of investment and economic growth. Inflation may also reduce a contry's international competitiveness, by making its exports relatievely more expensive, thus impacting on the balance of payments. Having stated the theoretical possibilities, if inflation is indeed detrimental to economics activity and growth, then how low should inflation be? The answer to this question, obviously depends on the nature and structure of the economy, and well vary from country to country. The estimated threshold is substantially higher for developing countries compared to that of developed countries. However, further shows that the inflation threshold in developing economies falls when we consider reduced group that exceed certain levels of institutional quality, and also find that the cost of inflation increases with the quality of institutions.