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The New Keynesian Phillips Curve
The New Keynesian Phillips Curve
Order ID 53563633773 Type Essay Writer Level Masters Style APA Sources/References 4 Perfect Number of Pages to Order 5-10 Pages Description/Paper Instructions
The New Keynesian Phillips Curve
The New Keynesian Phillips Curve (NKPC) is an economic model that explains the relationship between inflation and unemployment. It is based on the Phillips Curve, which was first introduced by A.W. Phillips in 1958. The Phillips Curve suggests that there is an inverse relationship between unemployment and inflation – as unemployment falls, inflation rises.
The NKPC builds on this idea by incorporating the role of expectations and price stickiness. The model assumes that firms have some degree of market power, meaning they can set prices above marginal cost. In addition, households have expectations about future inflation that affect their behavior.
In the short run, the NKPC suggests that there is a trade-off between inflation and unemployment. As firms raise their prices, inflation increases, and unemployment falls as more workers are needed to meet the increased demand. This trade-off is represented by the downward-sloping Phillips Curve.
However, in the long run, the trade-off disappears due to the role of expectations. If households expect higher inflation, they will demand higher wages, which will push up production costs for firms. In response, firms will raise their prices further to maintain their profit margins, leading to higher inflation. This cycle continues until inflation expectations are fully incorporated into wage and price-setting behavior.
Thus, in the long run, the NKPC predicts that there is no trade-off between inflation and unemployment, and the Phillips Curve becomes vertical at the natural rate of unemployment. This natural rate is determined by structural factors such as demographics, technology, and institutions, and is not affected by monetary policy.
The NKPC has important implications for monetary policy. In the short run, central banks can use monetary policy to influence the trade-off between inflation and unemployment by adjusting interest rates. Lower interest rates stimulate demand and reduce unemployment, but also increase inflation. In the long run, however, monetary policy can only affect nominal variables such as inflation and interest rates, and has no impact on real variables such as output and employment.
Moreover, the NKPC suggests that central banks should be forward-looking and focus on anchoring inflation expectations. If households and firms expect low and stable inflation, they will be less likely to demand higher wages and prices, and the central bank will have more credibility in maintaining price stability.
In summary, the New Keynesian Phillips Curve is a model that explains the relationship between inflation and unemployment in the short and long run, incorporating the role of expectations and price stickiness. The model suggests that there is a trade-off between inflation and unemployment in the short run, but not in the long run, and has important implications for monetary policy.
The New Keynesian Phillips Curve
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