Forder – Expectations and the Phillips curve

Notes on the Phillips curve

Expectations and the Phillips curve

Textbooks commonly draw attention to the point that if the policymaker pursues an inflationary policy, perhaps trying to lower unemployment, inflation-expectations will change, and this will shift the Phillips curve. This leads to the idea of the ‘vertical long run Phillips curve’. Expectational adjustment is an important idea. But many textbooks suggest that wage bargainers are really forming an impression of what the future holds. That fits well with ideas about economic agents having a very full understanding of their environment or perhaps forming anticipations by ‘rational expectations’.

But it should also be noted that other forms of adjustment result in the same long run outcome. For example, if agents simply react – perhaps unconsciously – to whatever they learn to be the normal circumstances of their society, on-going inflation will be incorporated in the wage bargain without there being any seeing into the future. Expectations then have nothing to do with it.

Both views lead to a vertical Phillips curve in the long run, but they are different in two ways. One is that the adjustment to the long run equilibrium might be very different. The other is that they suggest very different visions of the behaviour of economic agents. In one, the principles of strict rationality, it is suggested, guide the actual behaviour of trade unions, employers, and individual wage bargainers. In the other, actual reasoning could be entirely absent, with adjustment being more like something mechanical, instinctive, or evolutionary. There is much more that might be said on this, and it is more fully discussed in chapter 4 part 2 of James Forder, Macroeconomics and the Phillips curve myth Oxford: OUP

Commentary by James Forder, 24 September 2014