The U.S. economy is undergoing an expansionary period marked by low inflation rate and low unemployment rate. This goes against the theory of the Phillip’s curve presenting a tradeoff between unemployment and inflation. There are various factors responsible for this. First, the Federal Reserve Bank in the U.S. has targeted a stable expected inflation rate at 2% annually while pursuing maximum employment as well (Kahn 38). Second, price increases in some industries has been offset by price decreases in industries such as apparel, new vehicles and medical commodities. Lastly, there has been a general decrease in the producer price index for commodities such as food, energy and other goods which has offset the increase in producer price index of other commodities.
Philip’s curve shows an inverse relationship between unemployment and inflation (Fitzgerald, Brian & Juan 1). There is a tradeoff between unemployment and inflation. During boom when inflation levels are low, labor demand increases so as to increase production. As a result, wage rate increases due to the bargaining power of trade unions. Wage rate increases result in increased production costs thus price increases. Similarly, during a recession, labor demand decreases causing a decline in the wage rate. Costs of production decrease leading to a price decrease. When a government applies expansionary fiscal or monetary policy to expand the economy, unemployment rate drops below the natural rate of unemployment (NRU) in the short run. Wage rate is bid up and price increases due to increase in production costs. In the case where workers expected the inflation, they bid up their real wage rate while if the inflation is not expected, workers bid up their wages in nominal terms. In the former case, the economy moves back to the NRU with the same price level while in the latter case, the economy moves back to the NRU but with a higher price level.
Fitzgerald, Terry J., Brian Holtemeyer, and Juan Pablo Nicolini. “Is there a stable Phillips Curve after all?” Economic Policy Paper 13 (2013).
Kahn, George A. “Beyond inflation targeting: should central banks target the price level?” Federal Reserve Bank of Kansas City Economic Review 94.3 (2009): 37-66.