Unemployment, Nairu And The Phillips Curve

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Unemployment, NAIRU and the Phillips Curve

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Unemployment, NAIRU and the Phillips Curve

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Types of Unemployment

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Types of Unemployment • Frictional Unemployment: • Unemployment caused when people move from job to job and claim benefit in the meantime • The quality of the information available for job seekers is crucial to the extent of the seriousness of frictional unemployment Copyright 2006 – Biz/ed

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Types of Unemployment • Structural Unemployment: • Unemployment caused as a result of the decline of industries and the inability of former employees to move into jobs being created in new industries As the coal industry declined, many miners had difficulties utilising their skills to find work in new industries such as IT and service sector work. An example of structural change in the economy leading to unemployment. Title: On Duty. Copyright: Getty Images, available from Education Image Gallery

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Types of Unemployment

The demand for lifeguard services tends to exist in the summer but nothing like as much in the winter – an example of seasonal unemployment. Copyright: Swiassmautz, http://www.sxc.hu

• Seasonal Unemployment: • Unemployment caused because of the seasonal nature of employment – tourism, skiing, cricketers, beach lifeguards, etc. Copyright 2006 – Biz/ed

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Types of Unemployment

A fall in aggregate demand can lead to a decline in spending forcing businesses across the economy into closing with damaging effects on employment as a result. Copyright: Beeline, http://www.sxc.hu

• Demand Deficient: • Caused by a general lack of demand in the economy – this type of unemployment may be widespread across a range of industries and sectors • Keynes saw unemployment as primarily a lack of demand in the economy which could be influenced by the government Copyright 2006 – Biz/ed

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Types of Unemployment • Technological Unemployment: • Unemployment caused when developments in technology replace human effort – e.g in manufacturing, administration etc. Look: No workers! Robots rule where humans once stood! Titles: Assembly Line Workers, Electronic Factory. Copyright: Getty Images, available from Education Image Gallery

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Unemployment

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Unemployment • Short run and long run unemployment:

• Classical theory – short run unemployment is a temporary phenomenon; wages will fall and the labour market will move back into equilibrium • Long run – unemployment will be ‘voluntary’

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Unemployment • Keynesian Unemployment: • Unemployment in the long run may remain stubbornly high because of imperfections in the market – ‘sticky wages’

Widespread unemployment in some parts of the UK during the 1930s seemed to contradict the assumptions made by classical economists. Post 1945, Keynesian demand management put full employment through government intervention in the economy as a policy priority. Title: Poverty in Wigan. Copyright Getty Images, available from Education Image Gallery

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Inflation

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Inflation • Anticipated Inflation: • Occurs where individuals and groups correctly factor in expected changes in inflation into decision making e.g. wage negotiations, contract discussions, etc. Copyright 2006 – Biz/ed

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Inflation • Unanticipated Inflation: • Where changes in inflation are not factored into decision making – can lead to: – Changes in distribution of income – e.g.factoring in inflation above actual levels in wage negotiations may lead to a redistribution of income from employers to employees – Effects on Employment – e.g. wage settlements higher than inflation due to incorrect anticipation of inflation imposes costs on employers and may lead to job losses

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Inflation and Unemployment using AS/AD AS2

Inflation

AS1 The The short riserun in the AD fall economy leads in unemployment to ahas fall an in inflation is only Assume temporary; unemployment but shifts, unemployment rate of as 2%AS and a inflationary level of national will start pressures to rise again push and inflation the economy up to 3.75%. will end income giving an unemployment rate upProducers inofthe long try run toinexpand aforposition output withbut at 4%. AD rises some reason. unemployment increased cost at –4% employing but with more higher inflation. expensive Expansionary capital, paying fiscalworkers or monetary more policy to dowill work onlyetc. lead Increased to reductions cost results in in unemployment a shift in AS to in the the left short – workers run. In the start long to runbeunemployment laid off. will return to its natural rate. Attempts to reduce unemployment below the natural rate will be inflationary.

4.0% 3.75% 2%

AD2 AD1 U = 4%

U = 3%

Real National Income

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The Philips Curve

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The Phillips Curve • 1958 – Professor A.W. Phillips • Expressed a statistical relationship between the rate of growth of money wages and unemployment from 1861 – 1957 • Rate of growth of money wages linked to inflationary pressure • Led to a theory expressing a trade-off between inflation and unemployment Copyright 2006 – Biz/ed

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The Phillips Curve

Wage growth % (Inflation)

The Phillips Curve shows an inverse relationship between inflation and unemployment. It suggested that if governments wanted to reduce unemployment it had to accept higher inflation as a trade-off.

2.5%

Money illusion – wage rates rising but individuals not factoring in inflation on real wage rates.

1.5%

4%

6%

PC1

Unemployment (%)

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The Phillips Curve • Problems: • 1970s – Inflation and unemployment rising at the same time – stagflation • Phillips Curve redundant? • Or was it moving?

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The Phillips Curve

Wage growth % (Inflation)

An inward shift of the Phillips Curve would result in lower unemployment levels associated with higher inflation.

3.0%

1.5%

4%

6%

PC1

Unemployment (%)

PC2 Copyright 2006 – Biz/ed

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The Phillips Curve Inflation

Long Run PC To There Assume counter is athe short theeconomy rise term in fall unemployment, starts in unemployment with an inflation government butrate at aof once cost again 1% of but injects higher very resources high inflation. unemployment Individuals into the economy at now 7%.base – the their result is wage a Government short-term negotiations fall takes in unemployment onmeasures expectations to reduce but of higher inflation inflation. inunemployment This thehigher next period. inflation byIfan fuels higher expansionary further wagesexpectation arefiscal granted policy ofthen higher firms inflation that costs pushes andrise so AD–the to they process thestart rightto continues. (see shed the labour AD/AS Theand long run unemployment Phillips diagram Curve on slide iscreeps vertical 15) back at the upnatural to 7% again. rate of unemployment. This is how economists have explained the movements in the Phillips Curve and it is termed the Expectations Augmented Phillips Curve.

3.0%

2.0%

1.0% PC1 7%

PC3

PC2

Unemployment

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The Phillips Curve • Where the long run Phillips Curve cuts the horizontal axis would be the rate of unemployment at which inflation was constant – the so-called Non-Accelerating Inflation Rate of Unemployment (NAIRU) Copyright 2006 – Biz/ed

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The Phillips Curve • To reduce unemployment to below the natural rate would necessitate: • Influencing expectations – persuading individuals that inflation was going to fall • Boosting the supply side of the economy - increase capacity (pushing the PC curve outwards) Copyright 2006 – Biz/ed

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The Phillips Curve • Supply side policies have been focused on: • Education: – – – –

Boosting the number of those staying on at school Boosting numbers going to university Lifelong learning Vocational education

• Welfare benefits: – The working family tax credit – Incentives to work

• Labour market flexibility Copyright 2006 – Biz/ed

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The Phillips Curve • Expectations have been centred on: – Operational independence of the Bank of England – Tight control of public sector pay The independence of the Bank of England has taken away interest rate decision making from the government who may have been motivated by political ends – this has had the effect of influencing expectations. Messengers leaving the Bank of England with news of a change in interest rates in 1967 during the sterling crisis. Title: Bank Messengers. Copyright: Getty Images, available from Education Image Gallery

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