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The Phillips Curve and the Philippines Essay

According to Cristeta B. Bagsic, the Phillips Curve “depicts the trade-off between inflation and unemployment rate” (“The Phillips Curve and Inflation Forecasting: The Case of the Philippines”). Nowadays, the relationship depicted by the Phillips curve is specified in the following equation: πt = πe – γ(UR – UR*) + v

where πt is the inflation rate, πe is the expected inflation, γ is a parameter, UR is the unemployment rate, UR* is the natural rate of unemployment (NRU), and v is a supply shock variable. So while the importance of the negative relationship between unemployment and inflation was obvious enough from the beginning, it is now also apparent that there are other factors that influence the behavior of the Phillips Curve. It is beyond crucial that these additional factors be understood and measured well, if they are to be used in maneuvering developing economies such as the economy of the Philippines.

Perhaps the most notable addition to the basic inflation rate-unemployment relationship is the expected inflation or πe. What can be taken from the equation above is that there is a positive relationship between this expected inflation and the actual inflation rate. This is because the expectations involved are those of workers who are assumed to be anticipating rises in the inflation rate. When expecting a rise in inflation rate (for whatever reason), workers tend to withdraw their labor and demand that their employers increase their wages. Assuming that their employers subsequently comply, the workers’ buying power would increase and cause aggregate demand to increase as well.

This, in turn, would cause prices to increase which would trigger a rise in inflation – precisely showcasing the positive relationship that was pinpointed (“Economics Help – Helping to Simplify Economics” ). The next factor to be considered is the so-called Natural Rate of Unemployment. Bagsic sees this rate as the long-run unemployment rate because eventually “the difference between expected inflation and actual inflation should average to zero” (“The Phillips Curve and Inflation Forecasting: The Case of the Philippines”. When neglecting the rather volatile supply shock variable, the equation specified above will look like this as a result: γ UR = γ UR* or UR = UR*

which indicates that the natural rate is more or less what Bagsic suspects it to be – the unemployment rate one would expect to see in the long run. This is caused by the phenomenon already described wherein the workers’ expecting inflation unwittingly react in a way that further aggravates inflation. Also notable is how the NRU is sometimes called the NAIRU or the Non-accelerating inflation rate of unemployment as when unemployment is at this specific rate the corresponding inflation has no propensity to increase (“Economics Help – Helping to Simplify Economics” ).

The last notable factor in the equation provided is the supply shock variable v which has a significant historical background. Probably the most poignant supply shock was the 1970’s oil supply shock which is commonly thought to have triggered the unusual state of “stagflation” (high inflation and high unemployment) in several countries including the US. The exact nature of this variable is, as of yet, quite unpredictable (Amadeo). At this point, what is imperative is determining whether or not the Phillips Curve – or a variation of it – can apply to countries like the Philippines.

Bagsic’s findings suggest that there is truly a trade-off relationship between inflation and unemployment in the Philippine context. Her data shows that when actual employment rates are above (below) the NAIRU, they are usually accompanied by decelerating (accelerating) inflation rates. These trends are said to be relevant to investors and policymakers to aid with investment decisions and monetary/fiscal policies respectively (“The Phillips Curve and Inflation Forecasting: The Case of the Philippines”). It is important to keep in mind, however, that the Phillips Curve is not always accurate as evidenced by cases of stagflation; the information on the current trends in the Philippines must always be up-to-date in order to maximize the benefits reaped from the model.

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