Phillips Curves and Unemployment Dynamics: A Critique and a Holistic Perspective
The conventional wisdom that inflation and unemployment are unrelated in the long-run implies the compartmentalisation of macroeconomics. While one branch of the literature models inflation dynamics and estimates the unemployment rate compatible with inflation stability, another one determines the real economic factors that drive the natural rate of unemployment. In the context of the new Phillips curve (NPC), we show that frictional growth, i.e. the interplay between lags and growth, generates an inflation-unemployment tradeoff in the long-run. We thus argue that a holistic framework, like the chain reaction theory (CRT), should be used to jointly explain the evolution of inflation and unemployment. A further attraction of the CRT approach is that it provides a synthesis of the traditional structural macroeconometric models and the (structural) vector autoregressions (VARs).