The significance of inflation expectations in the monetarist Phillips Essay

The significance of inflation expectations in the monetarist Phillips Curve and t0he implications for the conduct of economic policy - Essay Example Inflation has been one of the most widely discussed topics by economist of the twenty first century. The term can simply be defined a general and persistent increase in the price level over a period of time Major economies of the world have been affected by it and economic analysts throughout the world have put in their expertise to curtail the damages that inflation is capable of doing to an economy. Mr. Alban William Phillips was one of those economists who will always be remembered for his contribution to the world of economics. He’s gathered fame all over the world for his research on inflation and unemployment. He started his work by gathering ninety five years of data relating to the UK wage inflation and unemployment. He was of the view that there is some direct or indirect link among these two important economic indicators. When he plotted the data on a graph, Mr. Phillips concluded that there is an inverse relationship between the rate of unemployment and the level of inflation in an economy. According to Mr. Philips there was a tradeoff between unemployment and inflation. High levels of unemployment tend to be linked with low levels of inflation and vice versa. Accordingly, if the government would want to reduce the unemployment rate it then it would have to settle with high rates of inflation. The Phillips curve concluded that deciding upon whether to have high rates of unemployment or to go for high rates of inflation was merely a matter of government policy as the two of them could not be achieved together – they were mutually exclusive. ... And this is how the price level rises and inflation occurs. The Phillips curve can further be divided into two time phases, namely the long run and the short run Phillips curve. The two curves are slightly different from each other in that they depict a different side of the picture. In the short run Phillips curve, high rates of unemployment are associated with low rates of inflation and vice versa. In such a situation the economists generally have to take a decision as whether to contain inflation or unemployment. Choices will generally be made after taking the overall economic situation of a country into consideration and definitely the decision made will not be beneficial for all. If the government decides to go for low rates of unemployment, low income earners will face a burden of high prices due to inflation. However, the long term Phillips curve looks at the story from a very different angle. The long run Phillips curve is normally drawn as a vertical line. This line can move both ways but generally it tends to move in (to a lower rate of unemployment) as time passes by. The idea behind long term Phillips curve is that in the long term there will be a certain rate of unemployment regardless of the level of inflation. This level will remain there since some people will always be unemployed due to job switching, frictional and seasonal unemployment. According to Mr. Friedman Milton, an economist, there is no tradeoff between the rate of unemployment and the rate of inflation in the long run as is denoted by the vertical Phillips curve. According to the long run Phillips curve, efforts made by economists to reduce the unemployment level below the natural rate of unemployment