A2 Economics – Phillips Curve – an Irish Perspective

Coming from Ireland I took a keen interest in the book entitled “Understanding Ireland’s Economic Crisis” edited by Stephen Kinsella and Anthony Leddin. It is a series of papers written by Irish academics which focuses on the causes of the largest destruction of wealth of any developed economy during the 2007-2010 global financial crisis. One paper on “The Phillips Curve and the Wage-Inflation Process in Ireland” lent itself to the Unit 6 of the A2 CIE syllabus. Remember the Phillips curve:

Bill Phillips, a New Zealander who taught at the London School of Economics, discovered a stable relationship between the rate of inflation (of wages, to be precise, rather than consumer prices) and unemployment in Britain over a long period, from the 1860s to the 1950s. Higher inflation, it seemed, went with lower unemployment. To the economists and policymakers of the 1960s, keen to secure full employment, this offered a seductive trade-off: lower unemployment could be bought at the price of a bit more inflation.

The graphs below show the unemployment and inflation in Ireland between 1987 and 2012.

Notice the following:
1987: – 17% unemployment with over 3% inflation
1988-99: – unemployment falls to 5% and inflation 1.5%
1999-2000: – inflation increases from 1.5% to just over 7%. This increase was largely due to expansionary fiscal policy (demand-pull inflation) and capacity constraints that led to higher costs of production (cost-push). This led to a classic Phillips Curve situation as unemployment was at 4% and the unexpected increase in inflation had caused workers to ask for higher wages. With the low rate of unemployment their bargaining position was very strong.
2001-2004: – during this period we see the typical Phillips Curve wage-price spiral. When there is an unexpected rise in inflation this is accompanied by inflationary expectations and Ireland saw a dramatic upsurge in nominal pay awards. As demand-pull inflation fed into cost-push Irish inflation remained relatively high over the next 3 years.
2005-2008: – with unemployment still around 4% wages continued to rise significantly as inflation remained around the 5% level.
2008-2011: the global financial crisis hits the world economy and unemployment in Ireland hits 15% in the space of 2 years. Meantime the trade-off with inflation starts with the CPI reaching over -6% at the end of 2009. More recently we see inflation getting up to 3% with the rate of unemployment increasing at a diminishing rate.

Although economic indicators are improving in Ireland there is still a long way to go before they can be more confident about its outlook.


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