Wage-price spiral This mechanism has sometimes been called the wage-price spiral, and this phrase captures well the basic mechanism at work o Low unemployment leads to higher nominal wages e In response to higher wages, firms increase their prices o In response to higher prices, workers ask for higher nominal wages e Firms further increase prices, so workers ask for further Increases In wages And so on, with the result being steady wage and price inflation 2003-7-20 6
2003-7-20 6 Wage-price spiral This mechanism has sometimes been called the wage-price spiral, and this phrase captures well the basic mechanism at work: ⚫ Low unemployment leads to higher nominal wages. ⚫ In response to higher wages, firms increase their prices. ⚫ In response to higher prices, workers ask for higher nominal wages. ⚫ Firms further increase prices, so workers ask for further increases in wages. ⚫ And so on, with the result being steady wage and price inflation
Mutations e From 1970 on, the original Phillips curve relation broke down there are two main reasons The change in the price of oil. The effect of this increase in nonlabor costs was to force firms to increase their prices given wages, to increase p An increase in u leads to an increase in inflation, even at a given rate of unemployment o Wage setters changes the way they formed expectations. This change came from a change in the process of inflation itself. This is the main reason for the breakdown of Philips curve relation 2003-7-20 7
2003-7-20 7 Mutations From 1970 on, the original Phillips curve relation broke down. There are two main reasons: ⚫ The change in the price of oil. The effect of this increase in nonlabor costs was to force firms to increase their prices given wages, to increase μ. An increase in μ leads to an increase in inflation, even at a given rate of unemployment. ⚫ Wage setters changes the way they formed expectations. This change came from a change in the process of inflation itself. This is the main reason for the breakdown of Philips curve relation