The relationship between inflation and unemployment: a critique of Friedman and Phelps

Author:

Rochon Louis-Philippe1,Rossi Sergio2

Affiliation:

1. Laurentian University, Sudbury, ON, Canada

2. University of Fribourg, Switzerland

Abstract

The ‘natural rate of unemployment’ was not an important part of Friedman's presidential address, although it is what the paper is remembered for. On the 50th anniversary of the paper, we argue that there is no ‘natural rate of unemployment’, and that the relation between inflation and unemployment is not the one assumed by Friedman or neoclassical theory. In Section 2 we present the conventional framework in which the Phillips curve is drawn by neoclassical economists. It emphasizes the exogenous nature of money, as well as the assumption that (a large part of) unemployment has to do with workers’ trade-off between paid work and leisure time (in a utility maximization perspective). Section 3 explains that the neoclassical framework is flawed, because money is endogenous and unemployment is not simply an outcome of workers’ choices with regard to the observed ‘equilibrium’ wage level. This section points out that inflation cannot be controlled with an interest-rate policy and that unemployment is the result of a lack of effective demand (hence it is involuntary). Section 4 provides two alternative macroeconomic analyses, one where inflation as well as unemployment are explained by the disorderly working of the banking system and another where conflict in the functional distribution of income within a monetary economy of production dominates. The conclusion offers some policy-oriented remarks as regards contemporary fiscal and monetary policies that a variety of countries have been adopting in their (largely ineffective) attempt to emerge from the crisis that erupted in 2008 at the global level – whose negative consequences still affect a relevant part of the world population.

Publisher

Edward Elgar Publishing

Subject

Economics and Econometrics

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