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Worksheet on the Phillips Curve

This worksheet will examine the question - has the Phillips curve relationship returned during the 1990s and 00s?

Background

The Phillips curve was a trade-off discovered by Professor Phillips between unemployment and the rate of increase of wages. It showed that as unemployment fell, the pressure on the labour market grew and the level of wage growth increased. The vertical axis of the Phillips curve later substituted inflation for wage growth, on the basis of empirical work.

This meant that policy-makers had a choice. If they wanted low unemployment they would have to put up with higher inflation and vice-versa. They couldn't have low unemployment and low inflation. The relationship, however, broke down in the 1970's as inflation and unemployment rose together - "STAGFLATION" (stagnation & inflation).

But has the trade-off returned in the 80s and 90s and 00s?

Step 1 - Gathering the data

To test whether the trade-off has returned we need figures for unemployment and inflation in recent years. The best source for this is the ONS datasets (http://www.bized.co.uk/dataserv/ons/onshome.htm). Click on this link to get there and get as much data as possible for the 80s and 90s and 00s for unemployment and inflation.

Step 2 - Processing the data

You should now have monthly data for unemployment and inflation from 1985 onwards. You now need to plot this data. There are various ways to do this:-

• To manually plot the data on graph paper
• To 'download' the data from Bized and put it into a spreadsheet to process it. To do this you will need to choose the option 'download CSV' on the ONS data page.
• If you are unable to download the data it could be typed into a spreadsheet or graphing package to process it

Once you have chosen the most appropriate option, carry out the necessary steps to plot unemployment on the horizontal axis and inflation on the vertical axis. Each month's or years's data should then be plotted as a separate point on the graph.

To make it clearer what is happening on the graph it may help to join the points sequentially or label the point with which year it is.

Step 3 - Analysing the data

The graph you have produced will probably closely resemble a spider's web at the moment, but we now have to work out whether or not there is a trade-off. There are two possible ways to do this:-

• Draw in by eye a line that fits the data as closely as possible. It should go roughly through the middle of all the pints and will almost certainly be a curve.
• If the computer package you have used to produce the graph has a regression function, then try to get a 'line of best fit' for the data

Choose whichever method you are able to and then consider the following points:-

How close are your points to the line you have drawn. If on average they are fairly close you may have found a good trade-off between unemployment and inflation. If the points are scattered all over the place and not close to the line you probably haven't.

Does your program give you a 'regression coefficient'? If it does (the figure may be called `r'), then look at the figure. The closer it is to 1, the better the fit of the data to the line.

Do you think that there has been a trade-off between unemployment and inflation in the last 20 years? If so, why?

When might it be possible for unemployment to go down, without inflation going up?

What other factors may affect inflation as well as the level of unemployment ('wage pressure')?

Step 4 - Updating the figures

To see what has happened recently with unemployment, inflation and earnings we need to go to the government pages. Click on the link below the table, to try to fill in the most up to date figures you can find for each of the variables:-

Latest Economic Indicators (http://www.hm-treasury.gov.uk/Economic_Data_and_Tools/data_index.cfm)

Research task -

• What is the difference between claimant unemployment and LFS unemployment?
• Which is the more accurate figure?