ECON6049 ECONOMIC

ANALYSIS
PRESENTATION
PRERNA DALAL
PRATHAM ARORA
RISHAV PRADHAN
FAYEEKA SIMANNA PRACHEE
WHY DOES LOW UNEMPLOYMENT NO
LONGER LIFT INFLATION?
Phillips Curve: The article starts by referencing the Phillips Curve, which was a
significant economic theory developed in 1958 by A.W. Phillips. The theory suggests an
inverse relationship between inflation and unemployment, where low unemployment tends
to be associated with high inflation and vice versa. This relationship has historically
guided economic policy and central bank decisions.

Wage Pressure: When unemployment is low, there is a concern that workers will demand
higher wages above and beyond the rate of inflation and productivity improvements. If
firms pass these increased labor costs on to consumers by raising prices, it leads to higher
inflation. This is a key reason why central banks, in such economic conditions, may raise
interest rates to slow down the economy and mitigate wage pressure.
High Unemployment and Inflation: On the other end of the curve, high
unemployment tends to keep wage growth in check and reduces consumer spending,
putting downward pressure on inflation. To counteract this, policymakers often cut
interest rates to stimulate economic activity and prevent deflation.

Central Bank Target: Most central banks in the developed world aim to target inflation
at around 2%. This modest level of inflation is considered optimal because it does not
significantly disrupt financial planning or confidence in the currency. It also allows for a
slight decline in real wages relative to prices, which can help preserve jobs during
economic downturns.
Expectations Matter: The article introduces the idea that the relationship between inflation
and unemployment is contingent on the expectations of economic actors, particularly workers.
If people expect inflation to be at a certain level, it influences their wage demands. For
example, if workers anticipate 2% inflation, they may ask for wage increases of 3 or 4%. This,
in turn, can push inflation higher.

Incorporating Expectations: In response to the limitations of the original Phillips Curve,

economists have augmented it by including expectations as a separate determinant of inflation.
High expectations of inflation can lead to persistently high inflation, even in the presence of
high unemployment.

Post-GFC Inflation: In the aftermath of the Global Financial Crisis, low inflation was not
surprising. The crisis disrupted economic expectations, and policymakers took measures to
stimulate economic recovery, which included keeping interest rates low. This, in turn,
influenced wage demands and contributed to low inflation.
In summary, the article suggests that the relationship between low
unemployment and low inflation is influenced by factors like wage
pressure, central bank policies, and economic actors' expectations. Post-
GFC, the disruption in economic expectations and the response of central
banks to stimulate growth played a role in the persistence of low inflation,
despite low unemployment.
Middle of the riddle

• The text explores how the Phillips curve has changed,

showing that it has recently shifted from a customary
downward slope to an oddly flat trajectory. The
economy's misrepresentation of spare capacity as a result
of low unemployment rates is one of the causes
contributing to this flatness. The story presents the
possibility that wages may eventually grow in reaction to
low unemployment, even if they would do so slowly at
first. It also implies that it is difficult to see the influence
of low unemployment in the statistics since it is
uncommon..
The essay examines how, ironically, central banks tighten policies in
response to inflation, which raises unemployment and contributes to the
flat Phillips curve. Because of the restriction of almost zero interest rates,
it raises questions about the restricted tools available to central banks in
their fight against inflation.

The perceived decline in the neutral interest rate as a result of

international capital flows presents difficulties for central banks and
restricts their capacity to withstand pricing pressures that are headed
downward. Though they may produce an infinite amount of money,
central banks are not able to compel expenditure, as the paragraph
highlights when considering their technological limitations.
A proposed solution involves collaborative efforts between
central banks and governments, a strategy gaining traction to
address pandemic-related challenges. The passage concludes by
highlighting the potential economic disaster if these partnerships
fail, leading to mass unemployment coupled with negative
inflation, removing the flatness from the Phillips curve.
ARGUMENTS RAISED

• Changing Dynamics of the Phillips Curve: The Phillips curve, traditionally depicting an inverse relationship between
inflation and unemployment, is argued to have undergone a transformation. Rather than a simple shift, it has become
strangely flat, indicating that inflation has become less responsive to changes in unemployment.
• Misrepresentation of Spare Capacity: The flatness of the Phillips curve is attributed to a potential misrepresentation of
spare capacity in the economy. Despite low unemployment rates, the article suggests that this might not accurately reflect the
actual slack in the economy.
• Delayed Wage Adjustments: The text introduces the idea that wages, although slow to adjust, may eventually rise in
response to low unemployment. It posits that the delay in wage adjustments could contribute to the seeming disconnect
between low unemployment and inflation.
• Rare Occurrence of Low Unemployment: The rarity of low unemployment is emphasized as a complicating factor. The
infrequency of this scenario makes it challenging to observe its impact in the data, contributing to the puzzle of low inflation
persisting in the face of low unemployment.
• Central Bank Policies: The article highlights the paradoxical role of central banks in contributing to
the flat Phillips curve. Central banks tend to tighten policies when inflation appears on the horizon,
leading to increased unemployment. This cyclic pattern may explain the disconnect between
unemployment and inflation.

• Technical Limits of Central Banks: The text explores the technical limits of central banks,
particularly the constraint of near-zero interest rates. Central banks may run out of room to cut interest
rates further, limiting their ability to counteract downward pressures on prices.

• Global Capital Flows and Neutral Interest Rate: Observers argue that global capital flows,
influenced by heavy saving from aging populations, have led to a "global savings glut." This
phenomenon contributes to a lower neutral interest rate, making it harder for central banks to offset
downward pressures on prices.

• Collaboration with Governments: The article suggests a potential solution involving collaboration
between central banks and governments. This approach, more prevalent post-COVID-19, aims to
address challenges by combining monetary and fiscal policies.
THANK
YOU