Home > Economics FAQs Blogs > How do expectations shift the Phillips curve?
How do expectations shift the Phillips curve?
Relevant Topics
This question pertains to topics in Macroeconomics, such as Inflation, Unemployment, Phillips Curve, Expectations
Definitions:
Phillips Curve: The Phillips Curve is an economic concept developed by A. W. Phillips, stating that inflation and unemployment have a stable and inverse relationship.
Expectations: In economics, expectations refer to the forecasts or views that consumers and firms have about future economic conditions. These can be about a wide range of factors, including inflation, unemployment, economic growth and interest rates.
Expectations: In economics, expectations refer to the forecasts or views that consumers and firms have about future economic conditions. These can be about a wide range of factors, including inflation, unemployment, economic growth and interest rates.
Detailed Explanation:
The Phillips Curve illustrates the relationship between the rate of inflation and the unemployment rate in an economy. It typically shows a trade-off between inflation and unemployment – higher inflation is associated with lower unemployment and vice versa.
However, this relationship is complicated by people's expectations about inflation. If people expect higher inflation in the future, they will demand higher wages to maintain their purchasing power. As a result, firms face higher costs, which they may pass on to consumers in the form of higher prices, leading to an increase in actual inflation.
This scenario is typically modelled as a shift in the short-run Phillips Curve to the right, which indicates that for any given rate of unemployment, inflation is higher than it would be without the expectation of increased inflation. If people continually revise their inflation expectations upwards, this can lead to a 'wage-price spiral', causing persistent and increasing inflation.
However, this relationship is complicated by people's expectations about inflation. If people expect higher inflation in the future, they will demand higher wages to maintain their purchasing power. As a result, firms face higher costs, which they may pass on to consumers in the form of higher prices, leading to an increase in actual inflation.
This scenario is typically modelled as a shift in the short-run Phillips Curve to the right, which indicates that for any given rate of unemployment, inflation is higher than it would be without the expectation of increased inflation. If people continually revise their inflation expectations upwards, this can lead to a 'wage-price spiral', causing persistent and increasing inflation.
Recent:
The 1970s Stagflation in the United States: In the 1970s, the US experienced a period of 'stagflation', with high inflation and high unemployment. This seemed to contradict the traditional Phillips Curve relationship. Economists such as Milton Friedman and Edmund Phelps argued that the explanation lay in people's inflation expectations. The oil price shocks of the 1970s had led people to expect higher inflation, shifting the Phillips Curve to the right and causing higher inflation at each level of unemployment.
Hyperinflation in Zimbabwe: In the late 2000s, Zimbabwe experienced hyperinflation, with monthly inflation rates reaching 79 billion percent in November 2008. One of the contributing factors to this hyperinflation was that people expected high inflation and so continually demanded higher wages, creating a vicious cycle of rising wages and prices.
Hyperinflation in Zimbabwe: In the late 2000s, Zimbabwe experienced hyperinflation, with monthly inflation rates reaching 79 billion percent in November 2008. One of the contributing factors to this hyperinflation was that people expected high inflation and so continually demanded higher wages, creating a vicious cycle of rising wages and prices.
Summary:
Expectations about inflation can shift the Phillips Curve. If people expect higher inflation, they will demand higher wages, leading to higher costs for firms, which may result in higher prices, increasing actual inflation. This causes the short-run Phillips Curve to shift to the right, meaning higher inflation at each unemployment rate. Examples of this can be seen in the 1970s stagflation in the US and the hyperinflation in Zimbabwe.
Whenever you're ready there is one way I can help you.
If you or your child are looking to Boost your A level Economics Grades in under 30 days, I'd recommend starting with an all-in-one support network where you get 24/7 access to a SuperTutor:
→ Join EdGenie 🧞♂️: Transform your A-Level Economics essays and exam marks (genuinely) with our comprehensive on-demand learning platform. This carefully curated course blends engaging content with effective exam techniques, the same ones that have empowered over 1,000 of my students to achieve an A or A* over the last 13 years.
Thanks for hopping on board EdGenie's Frequently Asked Questions!
I'm Emre, and I've got a big goal - to make A* education accessible to all A-level students.
And it Starts With You!
Emre Aksahin
Chief Learning Officer at Edgenie
Latest from our blog
Copyright © 2023
School
Join EdGenie 🧞♂️
Unlock Full Access to Examinable
Questions and Answers, Plus:
Questions and Answers, Plus:
- 600+ A* Tutorial Vault ⭐️
- 1-1 Live 24/7 SuporTutor Support 💬
- Live MasterClasses and EssayLabs 🎓
- Downloadable summary sheets 📄
Already a member? Log in
Subscribe to Wednesday Wisdoms
Get weekly updates on
A-Level Economics and Business insights right in your mailbox.
A-Level Economics and Business insights right in your mailbox.
Thank you!
Subscribe to the Edgenie newsletter!
Get weekly updates on the top news of the week, infographics, economic data, and more right in your mailbox.
Thank you!
Join EdGenie 🧞♂️
Unlock Full Access to Examinable
Questions and Answers, Plus:
Questions and Answers, Plus:
- 600+ A* Tutorial Vault ⭐️
- 1-1 Live 24/7 SuporTutor Support 💬
- Live MasterClasses and EssayLabs 🎓
- Downloadable summary sheets 📄
Already a member? Log in
30% discount offer!
30% discount offer!
Click the button to make this offer yours! Limited-time only!