The Evolution and Policy Implications of Phillips Curve Analysis

At the core of modern macroeconomics is some version or another of the famous Phillips curve relationship between inflation and unemployment. The Phillips curve, both in itspriginal and more recently reformulated expectations-augmented versions, has two main uses. In theoretical models of inflation, it provides the so-called “missing equation” that explains how changes in nominal income divide themselves into price and quantity components. On the policy front, it specifies conditions contributing to the effectiveness (or lack thereof) of expansionary and disinflationary policies. For example, in its expectations-augmented form, it predicts that the power of expansionary measures to stimulate real activity depends critically upon how price anticipations are formed. Similarly, it predicts that disinflationary policy will either work slowly (and painfully) or swiftly (and painlessly) depending upon the speed of adjustment of price expectations. In fact, few macro policy questions are discussed without at least some reference to an analytical framework that might be described in terms of some version of the Phillips curve. As might be expected from such a widely used tool, ,Phillips curve analysis has hardly stood still since its beginnings in 1958. Rather it has evolved under the pressure of events and the progress of economic theorizing, incorporating at each stage such new elements as the natural rate hypothesis, the adaptiveexpectations mechanism, and most recently, the rational expectations hypothesis. Each new element expanded its expIanatory power. Each radically altered its policy implications. As a result, whereas the Phillips curve was once seen as offering a stable enduring trade-off for the policymakers to exploit, it is now widely viewed as offering no trade-off at all. In short, the original Phillips curve notion of the potency of activist fine tuning has given way to the revised Phillips curve notion of policy ineffectiveness. The purpose of this articIe is to trace the sequence of