Question

Answer these questions using the Federal Reserve Bank of St. Louis's database.

Calculate the 12-month percentage increase in the consumer price index, and plot this, along with the unemployment rate. Do you observe a positive correlation, a negative correlation, or a correlation that is essentially zero? Can you find a Phillips curve relation or reverse Phillips curve?

Answer 1

The Phillips curve gives the inverse relationship between inflation and unemployment in the short run. This curve is based on the expectations of individual about the inflation rate based on the current policy actions. In the short run the equilibrium in the economy occurs where the aggregate demand equals aggregate supply. Any change in the aggregate demand or the supply changes the price level in the economy and hence inflation.

The figure below gives the monthly data plot of 69 years for unemployment and 12 month percentage change in CPI.

The correlation coeffocoent between the data is 0.23. Thus there exists a slightly positive correlation between the data but only 23% of the veriation can be explained by the data. The data on the other hand, weakly supports the reverse Phillips curve relation stating inflation causes unemploymnet or there exists a rather positive relation between inflation and unemploymnet.