The Phillips curve
The Phillips curve ranges as the dominant approach to wage and price modelling in macroeconomics. In the United States, in particular, it retains its role as the operational framework for both inflation forecasting and for estimating the NAIR U. In this chapter, we will show that the Phillips curve is consistent with cointegration between prices, wages, and productivity, and a stationary rate of unemployment, and hence there is common ground between the Phillips curve and the Norwegian model of inflation of the previous chapter.
The Norwegian model of inflation and the Phillips curve are rooted in the same epoch of macroeconomics. But while Aukrust’s model dwindled away from the academic scene, the Phillips curve literature ‘took off’ in the 1960s and achieved immense impact over the next four decades. Section 4.1.1 records some of the most noteworthy steps in the developments of the Phillips curve. In the 1970s, the Phillips curve and Aukrust’s model were seen as alternative, representing ‘demand’ and ‘supply’ model of inflation respectively (see Frisch 1977). However, as pointed out by Aukrust (1977), the difference between viewing the labour market as the important source of inflation and the Phillips curve’s focus on product market, is more a matter of emphasis than of principle, since both mechanisms may be operating together. In Section 4.2, we show formally how the two approaches can be combined by letting the Phillips curve take the role of a short-run relationship of nominal wage growth, while the main-course thesis holds in the long run.
This chapter also addresses issues which are central to modern applications of the Phillips curve: its representation in a system of cointegrated variables;
consistency or otherwise with hysteresis and mean shifts in the rate of unemployment (Section 4.3); the uncertainty of the estimated Phillips curve NAIRU (Section 4.4); and the status of the inverted Phillips curve, that is, Lucas’s supply curve (Section 4.5.2). Sections 4.1.1-4.5 cover these theoretical and methodological issues while Section 4.6 shows their practical relevance in a substantive application to the Norwegian Phillips curve.