The past several years have registered low inflation rates despite the unemployment rate going down to levels that were earlier linked to an increase in the rates of inflation. Notably, there has been a continued expansion and reduced unemployment since the end of the latest recession. Regardless, inflation has remained low. It follows that there are other factors in play separate from the Philips curve, which is the traditional model employed by economists to evaluate the correlation between inflation and unemployment ( Ormerod et al., 2013 ). The current economy does not demonstrate the past relationship between these two phenomena, thereby creating a necessity to study the underlying changes in the economy that have broken down the old link between inflation and unemployment.
The traditional Phillips curve suggests an inverse proportionality between the rates of unemployment and inflation. However, since the early 1990s, the economy has experienced a positive correlation between unemployment and inflation rates. The most plausible explanation for this development is that the United States has undergone a series of beneficial supply shocks that have enabled the country to keep inflation at a considerably low level ( Ormerod et al., 2013 ). These shocks are determined by calculating the difference between the actual value of the variable and the value that was projected when specialists introduced economic policies that established the National Rate of Unemployment (NAIRU).
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To determine why the traditional Phillips curve is not an accurate representation of the current economy, it is important to study such shock variables as the actual price of oil, variations in the actual unit cost of labor, and the fluctuations in the dollar price of imported items. For instance, the low inflation rates in the United States today are not a result of changes in the organisation of the economy; rather, they are caused by the falling import prices ( Ormerod et al., 2013 ). To that effect, integrating changes in import prices into the Phillips curves makes the model more accurate.
Reference
Ormerod, P., Rosewell, B., Phelps, P. (2013). Inflation/unemployment regimes and the instability of the Phillips curve. Applied Economics , 45 (12), 1519-1531.
