Principles of Macroeconomics / Unit 9 MAC 0838 review, 2 to 3 minutes
Why the Phillips Menu Failed
The idea
Through the 1960s the curve was read as a menu. Policymakers believed they could pick a combination of inflation and unemployment and use fiscal and monetary policy to reach it. The 1970s destroyed that reading. Attempts to hold unemployment low produced higher unemployment and higher inflation at the same time, which no single downward-sloping curve permits, and the episodes of 1973 to 1975 and 1980 to 1982 are the clearest cases. Two things shift the curve, and both work by moving aggregate supply. The first is a supply shock, such as an economy-wide jump in energy prices. The second matters more: a change in what people expect inflation to be. The tradeoff holds while people expect stable prices and are caught out by rising ones. Once they expect inflation and write it into wage agreements and price lists, short-run supply shifts left and the menu is gone.
In practice
Worked example, traced as three phases. In the first, demand rises and moves the economy up an unchanged short-run supply curve: prices run above what workers and firms expected when they set wages and prices, real wages fall below what was intended, employment and output rise, and inflation rises as unemployment falls. In the second, expectations catch up. Workers negotiate for the price level they now expect and firms reset prices, short-run supply shifts left, output falls back and the price level rises further, so unemployment and inflation rise together. In the third, policy responds to the new recessionary gap by raising demand again, output recovers and unemployment falls while the price level rises more slowly than before, so inflation falls too. Each phase is a shift in one of two curves, and the loop is what the scatter of decades of data actually shows.
Where people slip
Three cautions. The short-run tradeoff survives all of this as a short-run relationship, which is why it is still taught and still tested; what failed was the claim that it offers a stable menu of choices. Because expectations are one of the two shifters, the curve's position depends on beliefs about future policy, which is a moving target that policy itself changes. And this entry has said nothing about the long run: the question of whether the tradeoff exists at all once expectations have fully adjusted is unit ten's, and it takes the whole unit.
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