Political Economy Keynesian Economics Questions Medium
In New Keynesian Economics, the Phillips curve represents the relationship between inflation and unemployment. It is a key concept that helps explain the dynamics of the economy. The role of expectations in the Phillips curve is crucial as it influences the behavior of economic agents and their decision-making processes.
In the context of the Phillips curve, expectations refer to the anticipated future levels of inflation and unemployment. New Keynesian economists argue that these expectations play a significant role in shaping the actual outcomes of inflation and unemployment in the short run.
According to the New Keynesian perspective, individuals form their expectations based on various factors such as past experiences, economic indicators, and information available to them. These expectations then influence their behavior, particularly in terms of wage and price setting.
When individuals expect higher inflation in the future, they tend to demand higher wages to compensate for the anticipated loss in purchasing power. This leads to an increase in nominal wages, which in turn raises production costs for firms. As a result, firms may increase prices to maintain their profit margins, leading to higher inflation.
Conversely, if individuals expect lower inflation or even deflation, they may be willing to accept lower wage increases or even wage cuts. This can help reduce production costs for firms, leading to lower prices and potentially deflation.
The role of expectations in the Phillips curve is also relevant for understanding the trade-off between inflation and unemployment. In the short run, when inflation expectations are low, expansionary monetary or fiscal policies can lead to a decrease in unemployment without causing a significant increase in inflation. This is because individuals' expectations of future inflation remain low, and they do not demand higher wages.
However, if individuals' expectations of future inflation rise, expansionary policies may lead to higher inflation without a significant decrease in unemployment. This is because individuals will demand higher wages to compensate for the expected increase in inflation, offsetting the positive impact of expansionary policies on employment.
Overall, the role of expectations in the Phillips curve in New Keynesian Economics highlights the importance of understanding how individuals form their expectations and how these expectations influence their behavior. By considering expectations, policymakers can better anticipate the effects of their actions on inflation and unemployment, and make more informed decisions to stabilize the economy.