Political Economist

The Interpretations of the Phillips Curve and their Policy Implications

 1. Introduction

A.W. Phillips estimated the relationship between the change of nominal wage rate and the change of the rate of unemployment based on empirical evidences of the U.K from 1861 to 1957 in 1958. He found that there had been a negative relation between unemployment rates and the rate of the change of money wages. Since its appearance, the Phillips Curve has been considered one of the most fundamental frameworks in analyzing the inflation and (un-)employment policy in macroeconomics (Blanchard 2002: 149).

In this context, it is no surprise to see that various macroeconomists have interpreted the implications of the Phillips Curve in their own right: The Phillips Curve has played a role of the most controversial theoretical terrains in which different macroeconomic theories have been developed. The history of the interpretations of the Phillips Curve can be traced as following steps: firstly, along with Phillips’ original estimation, R.G. Lipsey (1960) provided microeconomic foundations for later interpretations. At the same time, P.A. Samuelson and R.M. Solow (1960) replicated Phillips’ observations for the U.S, but in slightly different ways. Second stage was dominated by the ‘natural rate of unemployment’ hypothesis based on the question of long term stability of the Phillips Curve. M. Friedman (1968) and E. S. Phelps (1968; 1969) criticized the Phillips Curve on the ground that it did not consider the role of inflationary expectations and thus failed to analyze the probable shift of the curve. The third stage of the development is characterized by rational expectations school’s critiques of previous understandings of the Phillips Curve (Frisch 1983: 30).

In this essay, we will trace this history of the interpretations of the Phillips Curve. While doing so, I will analyze characteristic features of each stage of interpretations along with their resultant policy implications.

2. The Historical Interpretations of the Phillips Curve

(1) The Original Phillips Curve and Lipsey’s Micro-foundation

In his 1958 article, Phillips tested the hypothesis that the price of labor services will rise when the demand for labor is high relatively to the supply of it like any other commodities. By the same reasoning, the rate of the change of nominal wages will also be determined by the rate of the change of demand for labor, namely the unemployment.

He argued on the basis of empirical data for the UK between 1861 and 1957 that there had been “a nonlinear, negative correlation between the change in money wages and the rate of change of unemployment” during this period except certain periods of rapid rises in import prices (Phillips 1958: 283; 284). Here, the meaning of ‘nonlinear correlation’ between two variables can be easily understood when we consider the situations where the rate of the change of nominal wages is either above or below the average at a given unemployment rate due to the decreasing or increasing demand for labor which is in turn determined by economic boom and recession – business cycle (Ibid., 290).

However, Phillips himself did not explain much the reasons why this ‘nonlinear’ relation had occurred during the periods of observations. He just mentioned the role of employers’ competitive bidding for hiring laborers and certain level of time lags. According to Lipsey, Phillips had in mind that “there would be more competitive bidding when the rate of the change of unemployment is negative than when it is positive.” This is simply because in the former case every other employer also wants to hire laborers, while in the latter case every other employer will dismiss laborers.

Another explanation is closely related to the effect of expectation. When the rate of the change of unemployment is negative, some employers may decide to pay more money wages than the rate is positive. And employers’ wage determination depends not only on the present need but also on what they expect to need in the future (Lipsey 1960: 21-21). If this is the case, the actual value for the rate of the change of nominal wage tends to be larger than the average when the unemployment rate is falling, and smaller than the average when the unemployment rate is rising.

Finally, even though Phillips admits that the third factor, namely the rate of the change of retail prices may also influence the change of nominal wage rates, he argues that this cost of living adjustment has “little or no effect on the rate of change of money wages except at times when retail prices are increased by a very rapid rise in import prices.” (Phillips 1958: 283-84; 285; 293; 296-97)

However, contrast to Phillips’ argument, the cost of living adjustment had had significant effects on the change of money wages, once it affected the change of real wages. As Lipsey already pointed out, the change of the cost of living caused “nominal wages to rise by more than they otherwise would have done” during the period of observations (Lipsey 1960: 8; 10). Furthermore, the change of retail prices can be an alternative explanatory variable to the level of unemployment and the change of the rate of unemployment (Ibid., 11; 12). If this is the case, the general relation among the change of (the rate of) nominal wages, the level and the change of unemployment rate and the retail price level (the cost of living) is yet to be analyzed.

At any rate, Phillips’ argument was not theoretical but only empirical observation. He did not develop any inflation theory or labor market model based on his ‘tentative’ conclusions. It was Lipsey who paved the foundations for later theoretical interpretations of the Phillips Curve.

Lipsey provided labor market model while confirming the negative relationship between the rates of the change of nominal wage on the one hand and the level of unemployment and its rates of change on the other in his 1960 article. In order to analyze this relation with systematic model, he assumes at the outset that there is only one single labor market in which demand for and supply of labor are adjusting to each other through the (wage) price changes. In this static system, both the equilibrium wage and employment are determined by the equality of demand for labor and supply of labor. At this steady state, the rate of the change in nominal wages is assumed to be zero. In other words, there is no change in the rates of nominal wage at this static situation.

However, if there is excess demand for labor in this labor market, this will lead nominal wages to rise. To use Lipsey’s term, the rate of change in the wage (dW/W) is determined by the difference between demand and supply of labor (Ld-Ls/Ls) through ‘the wage adjustment mechanism’ (Ibid., 13). The more the demand for labor exceeds the supply of labor, the faster wage rates will increase. If the demand and supply of labor are equal, then there will be no change in money wage rates. Thus, the wage adjustment function is dW/W = α(Ld-Ls/ Ls) where α captures the strength of the effect of excess demand for labor.

Furthermore, Lipsey established a negative correlation between the excess demand for labor (Ld-Ls/ Ls) and the rate of unemployment (U). He argues that an increase in excess demand for labor would decrease unemployment rate. However, even though there is high excess demand for labor, the unemployment rate can not be equal to or below zero (Ibid., 1960: 14-15).

Based on these two assumptions, he constructs the original Phillips Curve by combining the wage adjustment function with the unemployment rate directly. If there is positive relation between the change of the rate of nominal wage and the rate of excess demand for labor, we can easily conclude that the rate of change of money wage can be explained by excess demand for labor in the market. However, because excess demand for labor is not directly observable in the labor market, we should estimate this demand by looking at the level and rate of unemployment at given conditions.[1]

In this way, Lipsey constructed a stable negative relationship between the rate of the change of money wages and the unemployment, which the original Phillips Curve represented. All of this logical procedure can be illustrated as in the following figure (Ibid., 14; Frisch 1983: 37-40).

From this analysis, Lipsey draws some provisional conclusions: firstly even though the relationship between the rate of the change in nominal wage and unemployment rate is simply negatively related with each other, “the demand and/or supply curves might shift over time in such a way as to increase the disequilibrium in spite of the increase in nominal wage rate.” (Ibid., 16) Secondly, this model itself does not provide us with enough explanations of the real causes of the disequilibrium frequently occurred in the relationship between money wage change and excess demand of labor. Thirdly, this analysis does not tell us much about the influence of trade unions on the labor market wage adjustment processes (Ibid., 17).

He also derives some macro level implications from this analysis of a single labor market model: He argues that it is necessary to know not only the aggregate level of unemployment but also its distribution between various markets of the economy in order to predict the rate of change of nominal wage. Furthermore, because the aggregate analysis tends to overstate or understate the wage rate and unemployment rate of individual markets, it is necessary to consider various deviations from its macro level average (Ibid., 19).

With respect to the implications for the government policy, however, Lipsey warns that the estimated value can be shifted once we include additional variables and/or exclude particular years of observations. In other words, the shape of the curve is subject to change due to the time interval and other variables. Secondly, the rate of the change of nominal wages may not explained by the level of unemployment especially when the unemployment rate has remained unchanged for a long time. In other words, at a given unemployment rate, the causes of the change of nominal wages rate should be explained by other variables. Finally, we also have to estimate the relation between the change of nominal wage rate and the change of prices. Thus, without sufficient evidences and empirical analysis, it would be dangerous to argue as if the price were sorely determined by the change of wage rates (Ibid., 30-31).

(2) Samuelson and Solow’s Application of the Phillips Curve to the U.S Economy

In their 1960 article, Samuelson and Solow replicated the same negative relation between the increase in hourly earning and unemployment rate for the US based on empirical data from 1900 to 1960. Even though the curve shifted upward more than the case of the UK, this higher level can be easily attributed to different effects of the degree of trade unionism and/or administered wages. Compared to the UK, U.S Phillips Curve showed more ‘downward inflexibility.’ But this difference was also considered to be the results of the U.S fractioned and relatively more imperfect labor market system. In this way, they argue, the same negative relationship between the increase in wage and unemployment rate can be established (Samuelson & Solow 1960: 190).

Based on this empirical test, Samuelson and Solow went one step further: They modified their US type Phillips Curve into the relation between average price rise per annum and unemployment rate, and then concluded that policy makers should choose a certain level from “the menu of choice between different degrees of unemployment and price stability” (Ibid., 192).[2] In addition, they argued that the government should introduce ‘institutional reform policy’ in order to lessen “the degree of disharmony between full employment and price stability.” In other words, the government can deter the inflationary effects of the wage rises by increasing geographical and industrial labor mobility and improving the flow of information in the labor market (Ibid., 190; 194).

This modification can be easily understood, once we formulate some basic equations. The price level (P_t) can be denoted by P_t = P_t^e(1+μ)F(u, z) where P_t^e represents the expected price level, μ markup of the firms, and F(u, z) captures the effects of unemployment rate (u) and of the other factors (z) which affect wage determinations. Given the effects of the other factors, we can transform F(u_t, z) to be equal to 1 – αu_t + z. Replacing in the earlier equation, we can get P_t = P_t^e (1+μ)(1– αu_t + z). From this, we can also derive the following equation: π_t = π_t^e + (μ+ z) – αu_t where π_t denotes inflation rate which is defined as the rate of change of price from last year to this year at a given time, and π_t^e denotes expected inflation rate of given time (Blanchard 2002: 150-51). If this equation is correct, the rate of the change of price is considered to be determined by the expectation of inflation plus firms’ markups and unemployment rate. The lower the unemployment rate, the higher the inflation rate will be, given the expectation of price and other variables remain constant. In other words, the higher the nominal wage, the higher the inflation.

To examine the Samuelson and Solow model from this perspective, Samuelson and Solow can be considered to modify the relation between the rate of the change of nominal wage on the one hand and the level of unemployment and its rate of change on the other hand into the simple relation between inflation rate and unemployment rate, assuming that expectations of inflation (π_t^e) will be equal to zero. Secondly, they are also considered to argue that the government should adopt certain ‘institutional reform policy’ in order to reduce the effects of ‘administered wage,’ ‘trade union density,’ etc., which might contribute to maintain ‘downward inflexibility of the Phillips Curve’ and thus reinforce the inflationary pressure. Finally, from policy makers’ point of view, their model provides them with policy menu for certain level of inflation and unemployment rate. If there is excessively high unemployment, policy maker can attempt to reduce it by government’s fiscal deficit or expansionary monetary policy.

(3) Natural Rate of Unemployment Hypothesis and the Expectations-Augmented Phillips Curve

The main argument of the Phillips-Lipsey model was that the change of wage rates could be explained by excess demand or supply of labor in the market. Thus unemployment rate can be interpreted as an indicator of the level of excess demand or supply of labor. Another implicit idea of the original Phillips Curve was that this negative correlation between nominal wage rate change and unemployment rate would remain stable in the long period of time.

However, Phillips and Lipsey did not delve into the possibility of the shift or augmentation of this curve due to the change of economic agents’ expectations. Both Friedman (1968) and Phelps (1968; 1969) introduced the distinction between short term and long term perspective, and then argued that in the long run ‘expectations (anticipations) for the future inflation’ would affect both employers and laborers to bid higher nominal wages, thereby augmenting the Phillips Curve. Thus, with respect to the government’ economic policy, the trade-off between inflation and unemployment would no longer hold.

While Friedman developed this idea of ‘expectations-augmented Phillips Curve’ in the analysis of the role of workers’ expectations for future inflation, Phelps clarified the same notion on the labor demand side. In this section, I will examine both demand and supply side explanations of the expectations-augmented Phillips Curve. Let us start from Phelps’ argument.

Phelps assumes that products and labor markets are perfect except for incomplete information flows in the labor market. His famous ‘isolated island parable’ shows how both employers and employees search employments available in the situation of ‘imperfect information about their availabilities.’ This situation gives rise to ‘search unemployment’ or ‘wait unemployment’, as workers turn down or leave their previous jobs in attempts to search for better possibilities of being paid, and as employers delay hiring decisions in order to improve their knowledge of the labor market situations (Phelps 1968: 683-86; 1969: 149-50).

Together with this labor supply side’s imperfectly informed behaviors, Phelps introduces another assumption that the cost of an employer’s recruitment increases over time. Given constant differentials between the firm’s wage rate and the wage rates paid by other firms, sudden decreases in unemployment rate will tend to increase employees’ quit rate in the firm. Facing this situation, the firm has to decide to either reduce previous output level or hire new employees. However, if additional recruitment expenditures are larger than that of differential between the wage it pays and wages paid by other competing firms, the firms will choose to raise wage rates as an alternative to the increasing marginal cost of recruitment (Phelps 1968: 686-97).

This modified excess-demand model (what he calls ‘generalized excess-demand model’) yields an inverse, augmented non-linear relationship between the change of employment rates and the rate of the change of wages and/or prices as in the case of the Phillips Curve: If there is higher rate of employment, the firms will experience higher vacancy rates. In this situation, the firms tend to raise its relative wage rates compared to other firms in order to prevent abrupt reduction in the output from occurring. In this way, as employment rate increases and the vacancy rates of the firm increases, the change of wage rates increases at a greater proportion than otherwise it would be.

Furthermore, the firm will also have to forecast wage changes elsewhere in order to estimate the employment effects of its own wage rate determination. This means that firms’ wage decisions depends not only what they think other firms do today but also what they expect other firms will do in the future. In other words, firms’ actual wage rates will be determined by the expected rate of wage change plus relative wage differential paid by the firm under stationary wage expectation. If this is the case, under imperfect information market situations, adaptive expectation for the future increase in wages and prices will lead to unstable, explosive hyperinflation (Ibid., 697-706). In this way, Phelps incorporated the role of expectations in his demand side wage decision model.[3]

While Phelps examined the firms’ wage bidding activities by firms’ dynamic profit optimization model under imperfect information, Friedman paid attention to the role of employees’ adaptive expectations. In his inaugural address of the president of the American Economic Association, Friedman argues that the government’s monetary policy can not affect interest rate in the long run. Even though the initial increase in the quantity of money will lower interest rate temporarily, this policy will also boost the increase in spending and thus raise general price level, which in turn reduce the real quantity of money. In these circumstances, if the government attempts to keep monetary expansion, economic agents will expect prices to continue to rise in the near future (Friedman 1968: 5-7).

By the same token, Friedman argues that the government fiscal and monetary policy can not reduce unemployment rate permanently. He argues that there is always some level of unemployment which is consistent with equilibrium condition. In other words, at a given condition there is ‘natural rate of unemployment’ which reflects the current ‘degree of market imperfection,’ ‘stochastic variability’ in demand and supplies of labor, ‘the cost of gathering information’ about jobs and labor availabilities, ‘the cost of mobility,’ etc. (Ibid., 7-8).

From this natural rate of unemployment hypothesis, if the government adopts monetary policy in an attempt to reduce the actual unemployment rate relatively below the natural rate, this monetary expansion will generate overall increases in prices level. Even though the initial money growth may raise aggregate output and employment level temporarily, economic agents will try to retrieve their losses of real income based on their adaptive expectation of future inflation. In this way, the higher rate of money growth will induce nominal wages to rise, and this will in turn reverse the decline in unemployment level to its former natural rate. Thus, the government’s expansionary monetary policy and artificial employment policy form a vicious circle leading to an accelerating inflation (Ibid., 9-10).

This critique and argument can be also easily understood if we use algebraic equations developed in previous section. As we already noted, the Phillips Curve was derived from the assumption that expectation of inflation was equal to zero: from the original equation, π_t = π_t^e + (μ+z) – αu_t, π_t^e = 0. Thus, π_t = (μ+z) – αu_t.  However, if expectation of inflation is not equal to zero, what will happen to the original Phillips Curve? Let’s assume that expectation of next year’s inflation is determined by this year’s actual inflation, then π_t^e = θπ_t-1 where θ captures the effects of this year’s inflation on next year’s expected inflation rate. In replacing this expectation into the original equation, we can obtain π_t = θπ_t-1 + (μ+z) – αu_t.

From this equation, if the effect of this year’s inflation on next year’s expected inflation rate is equal to zero, we can say that inflation is negatively related with unemployment rate. And if other things remain the same, next year’s inflation will sorely depend on unemployment rate. If the effect of this year’s inflation on next year’s inflation rate is larger than zero, then we can predict that next year’s inflation will depend not only on unemployment rate but also on this year’s actual inflation rate. Finally, if θ is equal to 1, this equation can be denoted by π_t – π_t-1 = (μ+ z) – αu_t. In other words, unemployment rate affects not the inflation rate itself, but the change in the inflation rate. If this equation holds, in other words, expectation of inflation is based on previous year’s actual inflation (Friedman’s adaptive expectation), the rate of change in the inflation will increase if unemployment rate is reduced by the government monetary expansion (Blanchard 2002: 150-54).

Friedman’s concept of natural rate of unemployment can also be derived from this equation. The natural rate of unemployment is the unemployment rate where the actual inflation rate is equal to the expected inflation rate from this equation. In other words, from π_t = π_t^e + (μ+z) – αu_t, π_t = π_t^e = 0. Thus, 0 = (μ+z) – αu. If we solve for the unemployment rate, this will give u_n = (μ+z) / α. Replacing (μ+z) by αu_n in the original equation, π_t = π_t^e – α(u_t – u_n) or π_t – π_t-1 = – α(u_t – u_n). In other words, as Friedman said, the change in inflation rate is determined by the difference between the actual unemployment rate and natural unemployment rates. If the government attempt to reduce the actual unemployment rate relatively below the natural rate of unemployment rate, this policy will lead to the increase in inflation rates (Ibid., 154-56).

For our present purpose, it is necessary to pay attention to his critique of the Phillips Curve and its policy implications. Based on the notion of natural rate of unemployment, Friedman argues that even though Phillips’ analysis of the relation between unemployment and wage change is one of the greatest contributions, he fails to distinguish nominal wages from real wages. In other words, Phillips assumed that “nominal prices would be stable and expectation would remain unshaken and immutable” whatever happened to actual prices and wages (Friedman 1968: 8). Thus, for Friedman, the trade-off between inflation and unemployment is always a temporary option. “There is no permanent trade-off” between them (Ibid., 11)

In the end, Friedman asserted that traditional role of the government monetary policy should be revised. If the government can not control real interest rate, natural rate of unemployment, the real quantity of money, then monetary policy should focus instead on ‘the overall stability’ of economic system: monetary policy should be utilized to prevent money itself from being a major source of economic disturbance; It should provide ‘stable backgrounds for the overall economy,’ contributing to ‘offsetting major disturbances arising from other sources in the economic system’ (Ibid., 11-17).

(4) Rational Expectations Models and the Phillips Curve

The third stage in the interpretation of the Phillips Curve is the critique by rational expectations school. Lucas (1972a; 1972b) and Sargent (& Wallace 1973; Sargent 1973) went one step further from adaptive expectation model, and challenged the natural rate of unemployment hypothesis by introducing rational expectations agents model. They argued that inflationary expectations are formed by ‘rational’ economic agents who are taking into account all the information available about the economy. Based on this rational expectation agents model, Lucas and Sargent argued that the Phillips type trade-off would not exist even in the short run.

At first, Lucas was working on what he calls ‘expectation theory of the Phillips Curve,’ testing the presence of the short run Phillips relation based on the U.S time-series data for 1904-65. He concluded that the Phillips Curve existed at certain periods of time, but was a short run phenomenon in the U.S. Thus, without identifying other variables which might affect the shifts of the curve, the Phillips Curve should not be used as a foundation for policy decision (Lucas & Rapping 1969).

However, in his 1972 article “Expectations and the Neutrality of Money,” Lucas turned his focuses onto imperfect markets disturbances and economic agents’ hedging behaviors under inflationary situations. After modifying the original Phillips Curve into “the systematic relationship between the rate of change in nominal prices and the level of real output”(Lucas 1972a: 66), he tried to explain the reasons why real output increases in accordance with the increase in the quantity of money even when economic agents are assumed to be rational. If economic agents have rational expectations scheme, and the money is neutral in Friedman’s sense, how can we relate the increase in the supply of money with the real output increase? (Ibid., 66-67)

Regarding this question, he ascribed a main source of the existence of the Phillips relation to imperfect information flow in the market: if economic agents are free of money illusion, monetary expansion would have no real effects on aggregate output increase. However, economic agents’ information can only be conveyed to them by market price movements at certain situations. Thus, economic agents may not distinguish the real economic situations from monetary disturbances (Ibid., 84).

Lucas deals with this problem more explicitly in his attempt to testing the natural rate hypothesis. To summarize his arguments for our present purpose, ① neither adaptive expectations nor rational expectations agents model lead to the natural rate of unemployment hypothesis. ② even if we admit the existence of the natural rate of unemployment, there is no room for empirical inflation-real output ‘trade-off.’ The Phillips relation is a historical phenomena originated mainly from imperfect information in the market. In this way, Lucas historicized the existence of the Phillips relation, ascribing it to imperfect information constraints in the market (Lucas 1972b: 90-91; 100).

While Lucas developed his criticism of the Phillips Curve based on microeconomic models, Sargent started from the analysis of Phillips Cagan’s hyperinflation model. Cagan’s model was originally designed to analyze the dynamics of the government’s monetary policy and its effects on hyperinflation. In his model, once the government resorts to creation of money in order to finance its expenditures, this monetary response affects the overall price level and this in turn forms the public’s expected rate of inflation (Sargent & Wallace 1973: 333).

Here Sargent introduces the assumption of the public’s rational expectations for the future inflation in this model.[4] According to him, current rate of inflation is influenced by the current forecast of inflation for next period. But next period’s inflation rate also depends on the next period’s expectation of inflation two period hence. In this way, the public’s rational forecasting scheme projects their expectations for future inflation farther into the future. Given this rational formation of expectations, if the public forms its expectations of subsequent growth of money supply, from between the public’s expectation and the government money creation emerges a vicious circle (feedback) infinitely (Ibid., 1973: 331-33; 336-37; 349-50).

In this way, once the government starts to intervene in the economy through its expansionary monetary policy, the economic agents will raise their inflationary expectations, and this feedback process will in turn shift the Phillips Curve far away. If this is the case, there will be no room for the government to choose certain tolerable price stability at the expense of unemployment. As soon as the government decides to adopt expansionary monetary policy, the trade-off between unemployment and inflation will disappear.

3. Conclusion

Until now, we have followed the history of various interpretations of the Phillips Curve from Lipsey’s micro foundation to rational expectation school’s radical critiques. From historical perspective, the Phillips Curve has been a terrain in which various macroeconomic theorists assert the validity of their arguments.

When Phillips drew downward-slopping curve between the change of the rate of nominal wages and the rate of unemployment, he did not explain macroeconomic meanings of his observations. In addition, even though he mentioned the possibility of the firms’ competitive bidding for money wages, he did not explain systematically the underlying motives behind the firms’ activities. Finally, by excluding the effects of the cost of living on nominal wage adjustment, he left the relation between nominal wages and overall price level untouched.

While Phillips stayed on his empirical observations, Lipsey tried to provide initial labor market model in which excess demand for labor contributed to generate the non-linear relationship between the changes of the rate of nominal wages and the rate of unemployment. However, he was still warning against any hasty policy derivation from the original Phillips Curve, because he thought that there remained a lot of variables unexplored and relations among variables being excluded.

It was Samuelson and Solow who modified the original Phillips relation into the relationship between ‘inflation rate’ and ‘unemployment rate.’ With this modification, they were able to recognize the presence of the same curve in the U.S economy, and to argue that the government should choose trade-off between two dualistic values. From then on, the Phillips Curve had been widely understood as an omnipotent guide for (anti-)inflation policy and exploited by myopic post-Keynesian macroeconomic policy.

Those who criticized this (mis-)understanding was not from ‘classical Marxian’ or ‘Keynesian’ economists who had traditionally advocated the class interest of laborers but from one group of radical neoclassical economists – ‘monetarist’ equipped with the Ricardian quantity theory of money. Both Friedman and Phelps argued that policy trade-off between inflation and unemployment was only a temporary phenomenon. Considering adaptive expectations of the economic agents, the government’s monetary expansion would only lead to inflation. Thus, the role of the government should be restricted under the principles of overall price stability of economic system.

While both Friedman and Phelps focused on the role of economic agents’ adaptive expectations for future inflation, Lucas and Sargent went one step further in order to solve the probable ‘paradox’ of the assumption of adaptive expectations. By assuming the ‘rationality’ of economic agents’ expectations – information process schemes based on the availability of economic variables, they argued that economists did not have to resort to ‘natural rate of unemployment hypothesis’ in order to reject the government monetary intervention. From now on, any types of the government’s monetary intervention would be anticipated and analyzed by rational economic agents’ information process scheme, thus economists would no longer have to historicize the Phillips relation: the trade-off between inflation and unemployment would no longer exist even in the short run.

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