How the Australian Relationship Between Unemployment and Inflation has Changed - Oliver Bolosky

            The relationship between inflation and unemployment has always been hard to pin down- it seems that establishing a trend that relates the two often doesn’t stand the test of time. This comes with a couple questions such as “why don’t the trends stay consistent” and “how have the models of this relationship changed over time.” This blog will focus on investigating these questions, specifically through looking at the evolution of these models in Australia. Starting with an earlier model dating back to the 50s, when William Phillips is credited as discovering the “Phillip’s curve” which presented the idea of an inverse relationship between inflation and unemployment. The major issue with this model is that it was predicated on the idea that it assumed that inflation expectations wouldn’t change. “When these findings were published, they suggested that policy makers faced a tradeoff between inflation and unemployment.” (Blanchard, 160). The result of which is that as inflation expectations changed, the model no longer became accurate, and inflation started accelerating in a way that wasn’t anticipated.

This increasing unemployment and inflation is relatively well known in the United States, with the stagflation of the 70s being recent and painful enough to entrench the memory into the American zeitgeist. Australia’s situation likely isn’t as well known to an American audience, so it’s best to start by looking at the Australian situation in the 70s. When the Phillips curve relationship broke down the Australians faced the same stagflation as America. “unemployment more than doubled in about 18 months to 5.3 percent in December 1975 when inflation had hit 14.4 percent.” (Yeates). The Phillips tradeoff had broken- both inflation and unemployment were rapidly increasing when they were supposed to be inversely correlated. Eventually the ill-advised continual expansion of the 70s came to an end, and a new consensus had to be formed. It was clear that the reaction in inflationary expectations had to be accounted for in order to accurately model the relationship between unemployment and inflation. This resulted in the creation of the expectation augmented Phillip’s curve “or the accelerationist Phillips curve (to indicate that a low unemployment rate leads to an increase in the inflation rate and thus an acceleration of the price level).” (Blanchard, 163). The major distinction here is that the rate of change in inflation is what’s predicted by the equation- not an absolute level of inflation. This more accurately predicts the kind of snowballing seen in the 70s, where inflation wasn’t just continuing to increase but was increasing at an increasing rate.

             Jumping forward now to 1999, estimations of the Phillips curve have become increasing complex. In a study attempting to model the relation in order to describe what causes inflation, what inflation will be, and how to approach it from a policy standpoint, it’s noted that “The framework of the 1990s has much in common with the one enunciated in Holmes’ paper written in 1971, although the modern version would contain some elements not present in the earlier version.” (Gruen, 253). Holmes was an advocate of the expectation adjusted Phillip’s curve, and Gruen’s paper advocates for something similar. Specifically, Holmes was a proponent at the time of using recent price changes as an indicator of inflation expectations and incorporating it into the relation. Almost three decades later more complex and accurate representatives of expectations are used incorporating both elements that predict based off of inflationary behavior farther back, as well extrapolating current trends. Additionally, a general formula for a relation between unemployment and inflation can’t be established between countries due to the multivariate nature of the relation being different because of the idiosyncrasies of differing economies. For example “The presence of import prices reflects the significant proportion of imported goods that are either consumed or enter the production chain in Australia.” (Gruen, 226) A model used for a different country might not accurately weigh the role of imports in the Australian economy, so a unique formula to Australia must be made to best fit the correlation. Overall, because the behavior of inflation and inflation expectations are the product of many different variables that relate to inflation in inconsistent ways between times and countries, it’s likely that Australia like many countries will have to continually re-evaluate the relation between unemployment and inflation.

 

 

 

 

 

Bibliogrpahy

Blanchard, Olivier. Macroeconomics Seventh Edition. Pearson, 2017.

David Gruen, Adrian Pagan, Christopher Thompson, The Phillips curve in Australia, Journal of                   Monetary Economics, Volume 44, Issue 2, 1999, Pages 223-258, ISSN 0304-3932,                              https://doi.org/10.1016/S0304-3932(99)00024-0.

Junankar, P.. (2002). Comment on ‘Fiscal Policy and the Job Guarantee’. Australian Journal of                     Labour Economics (AJLE). 5. 265-269.

Yeates, Clancy. “What's Stagflation, and What Would It Mean for You?” The Sydney Morning Herald, The Sydney Morning Herald, 24 Mar. 2022, https://www.smh.com.au/business/the-economy/what-s-stagflation-and-what-would-it-mean-for-you-20220315-p5a4q9.html.