Question

(a) What is the major policy implication of the original Phillips Curve? How did it affect macroeconomic policies at that time? What major contribution it had made before the early 1970s? What kind of problem had emerged from the 1970s?

(b) Use Friedman’s Expectation Augmented Phillips Curve to explain how the above problem emerged? What is the major policy implication of Friedman’s Expectation Augmented Phillips Curve?

Answer 1

a) The phillips curve is a downward sloping curve, which reflects the inverse relationship between inflation and unemployment in the economy. However, the phillips curve relationship suggests the extent to which both the monetary and fiscal policies might be used to control inflation without having higher levels of unemployemnt. It provides a pathway which reflects that the rate of inflation which can be tolerated with a given level of unemployment.

According to the phillips curve theory, there is a tradeoff between the rate of inflation and the unemployment rate in the short run. while in the long run,there is no such visible tradeoff. In the long run, the phillips curve is a vertical line.

However, in the 1970's, the world witneses a situation, where both inflation and unemployment co-existed. This came to be known as stagflation. According to the proponents of the phillips curve theory, this could not happen.Thus the theory failed to provide an explaination for the prevalent situations in the 1970's.