SEM-6

MACROECONOMICS
PROJECT REPORT

ANALYZING THE PHILLIPS CURVE RELATIONSHIP

AUGUSTYA KUMAR
RASHI GULATI
NIHARIKA DAKA
PARNIKA BATRA
ANANT SAXENA
 TABLE OF CONTENTS

1. Introduction……………………………………………………….

2. Impact of the Shock Period (COVID-19)………………………...

3. Central Banks’ Reaction……………………….............................

4. Unemployment and Worker Categories…………………………..

 Introduction

The report examines the Phillips Curve relationship between inflation and unemployment by
comparing two distinct economies: the United Kingdom (UK), a developed nation with a well-
established financial system and stable institutions, and the Philippines, a developing country
experiencing rapid growth and structural challenges. By selecting one developed and one
developing economy, we seek to understand how varying economic conditions shape the
inflation-unemployment dynamic. The UK illustrates how advanced economies regulate
inflation and unemployment through monetary policy and labour market flexibility, whereas
the Philippines highlights the challenges faced by developing economies in managing these
issues amid external shocks and structural constraints. This comparative analysis aims to assess
the relevance of the Phillips Curve across different economic environments and identify key
factors contributing to deviations from its traditional inverse relationship.

Phillips curve of the two countries

Data Collection and Analysis

For the UK and the Philippines, annual data on CPI inflation rates and average unemployment
rates were gathered. Scatter plots were created for each country, plotting inflation against
unemployment, and trend lines were added to visualize the relationship.
Results:

➢ United Kingdom—

United Kingdom
9
8
7
6
Inflation

5
4
3
2
1
0
0 1 2 3 4 5 6 7 8 9
Unemployment

In UK, the scatter plot shows a negative relationship between inflation and unemployment but
has a very weak correlation of -0.017 between the two variables. This do not align with the
Philips curve hypothesis which suggests that an inverse relationship between inflation and
unemployment. The trend line showed a slight downward slope, indicating that as inflation
increased, unemployment tended to decrease slightly maybe due to increased demand in labour
and goods.

➢ Philippines—

Philippines
4.5
4
3.5
3
Inflation

2.5
2
1.5
1
0.5
0
0 1 2 3 4 5 6 7 8 9

Unemployment

In UK, the scatter plot shows a positive relationship between inflation and unemployment but
has a very weak correlation of 0.329 between the two variables. This do not align with the
Philips curve hypothesis which suggests that an inverse relationship between inflation and
unemployment. The trend line showed a slight downward slope, indicating that as inflation
increased, unemployment tended to decrease slightly maybe due to increased demand in labour
and goods.

Possible explanation of the relationship

➢ United Kingdom—

1. Developed economy with stable inflation expectation-

The United Kingdom, as a developed economy, benefits from well-established institutions,
including the Bank of England, which is committed to maintaining a target inflation rate of 2%.
The country has a strong track record of sustaining low and stable inflation over time. This
consistency in inflation expectations helps dampen the responsiveness of inflation to
fluctuations in unemployment. For instance, even during periods of elevated unemployment—
such as in 2011-2012, when the unemployment rate peaked at approximately 8%—inflation
remained relatively stable, varying within a narrow range of 2% to 4%.

2. External Factors and Globalisation-

Being a very open economy, the UK's inflation is greatly impacted by international variables
like supply chain interruptions, commodity prices, and exchange rates. For instance, the Brexit
referendum in 2016 caused the pound sterling to depreciate sharply, raising import costs and
temporarily raising inflation (which reached 2.9% in 2017). However, outside forces—rather
than domestic demand or labour market conditions—were responsible for this inflation.

Similar to this, the UK saw a spike in inflation in 2022 (to 7.9%) as a result of supply chain
disruptions brought on by the Russia-Ukraine war and shocks to global energy prices. Changes
in unemployment, which were low at about 3.7%, were not directly related to this inflation.

3. Structural Transformations in the Labor Market-

Over the past few decades, the UK labour market has experienced substantial structural shifts,
including greater flexibility, an expansion of part-time and gig economy employment, and
modifications in wage-setting mechanisms. These changes have diminished the responsiveness
of wages to fluctuations in unemployment, thereby weakening the conventional Phillips Curve
relationship.

A notable example of this trend occurred during the 2010s when the UK witnessed persistently
low wage growth despite a decline in unemployment. This phenomenon, commonly known as
the "productivity puzzle," indicated that rising employment levels did not necessarily lead to
significant wage pressures or increased inflation.

➢ Philippines—

1. Cost-Push Inflation
The Philippines relies heavily on imported energy and food, making its economy highly
vulnerable to global price fluctuations. When the costs of these essential commodities increase,
businesses encounter higher production expenses, which often translate into rising inflation. At
the same time, these increased costs can erode profitability, leading to reduced hiring or even
workforce reductions, ultimately contributing to higher unemployment.

2. Structural Issues in the Labour Market

The Philippines faces significant structural challenges in its labour market,
including underemployment, informal employment, and skills mismatches. These issues make
it difficult for the economy to absorb shocks, leading to simultaneous increases in inflation and
unemployment.

In 2018, underemployment in the Philippines was 16.1%, reflecting the prevalence of low-
quality jobs and part-time work. Many workers in the Philippines are employed in the informal
sector, which offers little job security or wage growth. When inflation rises, these workers are
often the first to lose their jobs, contributing to higher unemployment.

3. Weak demand side pressures-

Because of low consumer purchasing power and income inequality, the Philippines frequently
faces weak demand-side pressures, even in the face of high inflation in some years. Businesses
are less able to pass on increased costs to customers as a result, which lowers profitability and
results in layoffs.
In the Philippines, the majority of households spend a significant amount of their money on
energy and food. Consumers reduce their discretionary spending as prices for these
commodities increase, which lowers demand for goods and services and results in job losses.

Supply vs Demand side pressures in both the countries

➢ Supply side pressure—

The Philippines is highly exposed to supply-side shocks, especially in food prices, due to
its dependence on imports and frequent natural disasters. Food inflation is often influenced
by global price fluctuations, supply chain disruptions, and extreme weather events like
typhoons.

Historical trends show sharp spikes in Philippine food inflation during supply disruptions.
In 2018, for instance, the rice crisis—driven by supply constraints and rising global
prices—led to a surge in food inflation.

Rising food prices increase business costs, reducing profitability and leading to layoffs.
Simultaneously, higher food inflation contributes to overall price increases, reinforcing a
positive correlation between inflation and unemployment.

The UK is less exposed to supply-side shocks than the Philippines, owing to its diversified
economy and stable supply chains. However, food inflation can still be affected by external
factors such as global commodity price fluctuations and exchange rate movements.
Historical trends indicate that UK food inflation has remained relatively stable, with
occasional spikes during periods of global price volatility, such as the Global Financial
crisis in 2008, Covid-19 and Russia-Ukraine war in 2022. However, these increases have
been short-lived and have had minimal impact on overall inflation or unemployment.

➢ Demand-side pressures—

The UK has a strong consumer-driven economy, with high levels of consumer spending
supporting economic growth and employment. However, the demand-side pressures on
inflation are often moderated by the Bank of England’s (BoE) monetary
policy and stable inflation expectations. From the graph we can see that, the consumer
spending in UK has remained robust even during times of uncertainties like Brexit exit
and during Covid 19, the economy recovered quickly in 2021. High consumer spending
supports job creation and reduces unemployment, but the BoE’s effective management
of inflation expectations and monetary policy prevents excessive demand-side
inflationary pressures. This creates a negative but weak relationship between inflation
and unemployment.

The consumer spending is Philippines is moderate but the demand-side pressures

remain low than UK due to sluggish wage growth and income inequality. In 2020,
spending dropped due to the COVID-19 pandemic, yet food inflation remained high
due to supply disruptions. The seasonal spikes suggest periodic increases, likely due to
festive seasons, agricultural cycles, or remittance inflows.
 Weak demand-side pressures prevent businesses from passing higher costs onto
consumers, reducing profitability and leading to layoffs. This reinforces the positive
correlation between inflation and unemployment.

The Impact of the COVID-19 Pandemic

In this section, we will look at the economies of the United Kingdom (UK) and the Philippines
during the COVID-19 pandemic and their subsequent recovery periods. The pandemic had a
profound impact on global economies, disrupting industries, labor markets, and government
finances. The UK and the Philippines, despite their differing economic structures and levels of
development, both faced significant challenges in managing the crisis. We will analyze key
economic indicators such as GDP growth, employment rates, inflation, and government
stimulus measures to understand how each country navigated the economic downturn.

United Kingdom
Inflation:

The above graph shows the annual inflation trends in the UK, measured in terms of the
Consumer Price Index (CPI), food, and energy prices. For many years, the UK maintained a
stable inflation rate, with the Bank of England successfully keeping inflation close to its 2%
target for CPI inflation. However, the COVID-19 pandemic disrupted this stability, leading to
a historic surge in inflation.
While inflation remained relatively low during the start of the pandemic in 2020 due to
weakened demand and government support measures, the post-pandemic recovery period
brought significant inflationary pressures. As economic activity resumed, supply chain
disruptions and increased consumer spending contributed to rising prices. Additionally, the
onset of the Russia-Ukraine war in early 2022 exacerbated inflation, particularly in the energy
and food sectors.
The sharp rise in global energy prices, driven by supply constraints and international sanctions,
led to a sharp increase in energy costs. Similarly, disruptions in global agricultural supply
chains and higher production costs pushed food prices upward. Given the substantial weight of
both energy and food within the CPI basket, their inflationary spikes had a noticeable impact
on overall inflation levels.
Unemployment:

Unlike the case of inflation, the unemployment levels in the UK during the COVID-19
pandemic were relatively better compared to the aftermath of the 2008 financial crisis.
However, it is important to recognize that, before the pandemic, the UK had been experiencing
a steady decline in unemployment for nearly eight years. This trend was reversed when
COVID-19 hit.
Despite this sudden economic downturn, the UK government’s intervention played an
important role in preventing an unemployment crisis. One of the most significant measures
introduced was the furlough scheme, where the government covered a large portion of wages
for millions of workers who would have otherwise lost their jobs. This policy helped keep
unemployment levels significantly lower than they could have been. Some economists estimate
that, without the furlough scheme, the UK's unemployment rate could have surged to around
12%.
However, while the furlough scheme prevented mass unemployment in the short run, it also
had longer-term economic consequences. The large-scale injection of government funds into
the economy contributed to increased consumer spending once restrictions eased. This influx
of money likely played a role in the inflationary pressures seen in the years following the
pandemic.
Philippines
Inflation:

The above graph illustrates the inflation rate of the Philippines over time. In the initial months
of the pandemic, inflation indicators remained relatively stable, as strict lockdown measures
led to weak consumer demand and reduced economic activity. With businesses shutting down
and mobility restrictions in place, spending declined, preventing a significant rise in prices
during 2020.
However, as the economy gradually reopened and recovery took place, demand for goods and
services rebounded, contributing to a steady rise in inflation from 2021 onwards. The inflation
rate surged sharply post-2022. One of the biggest contributors to this inflationary spike was the
Russia-Ukraine war, which led to severe supply chain disruptions. As a nation highly
dependent on imports for food, fuel, and raw materials, the Philippines was particularly hit
hard. The rising costs of imported oil and agricultural goods intensified inflation, pushing up
transportation costs and food prices, which have a significant weight in the Consumer Price
Index (CPI).

Unemployment:
With the mandated closure of establishments, the lockdown forced a significant portion of the
Filipino workforce into unemployment, causing the unemployment rate to peak at 17.6% in
2020. During this period, the number of unemployed individuals nearly tripled, reaching
approximately 7 million. This drastic rise was largely driven by the country's heavy reliance
on tourism and related industries, which came to a standstill due to strict travel restrictions and
lockdown measures. Hotels, airlines, travel agencies, and hospitality businesses, which
traditionally employed millions, were among the hardest hit, leading to widespread job losses.
Additionally, the large presence of small and medium enterprises (SMEs) in the Philippines
further fueled the employment crisis. Many of these businesses lacked the resources to
transition to remote work or digital operations. As a result, a significant number of small-scale
enterprises were forced to lay off employees or shut down entirely, contributing to the sharp
rise in unemployment.
However, as the economy gradually reopened and restrictions were lifted, businesses began to
recover, rehiring workers and expanding operations. The revival of tourism and the retail and
service industries played a crucial role in restoring employment levels. By 2023, the
unemployment rate had significantly declined to 4.2%, marking a return to pre-pandemic
levels.
 Monetary Policy Responses to Price Changes During COVID-19: UK and
Philippines (by respective Central Banks)

Divergent Policy Paths: Bank of England and Bangko Sentral ng Pilipinas (Bank of
Philippines)

The COVID-19 pandemic created unprecedented challenges for central banks worldwide, with
the Bank of England (BOE) and Bangko Sentral ng Pilipinas (BSP) implementing markedly
different monetary policy responses reflective of their distinct economic conditions,
institutional frameworks, and inflation dynamics.

(Above table shows leading inflation data movers providing global context to our report)

➢ United Kingdom: Bank of England's Response

When COVID-19 emerged, the Bank of England swiftly implemented an aggressive

accommodative stance to stabilize financial markets and support economic activity. In March
2020, the BOE cut its Bank Rate from 0.75% to an unprecedented low of 0.1% and expanded
its quantitative easing program to £895 billion.

This emergency response aimed to prevent a financial crisis while supporting household and
business credit access amid collapsing demand.

As the pandemic evolved and supply chain disruptions intensified, the UK experienced rapidly
accelerating inflation. By November 2021, CPI inflation had risen to 5.1%, significantly above
the BOE's 2% target. The MPC's response to these price pressures marked a decisive policy
shift – in December 2021, it raised the Bank Rate by 0.15 percentage points to 0.25%, becoming
one of the first major central banks to tighten monetary policy following the pandemic.
This initial rate hike represented a critical inflection point in the BOE's policy stance, signalling
prioritization of price stability despite ongoing economic recovery concerns. The Monetary
Policy Committee's judgment reflected growing concerns about:

• Persistent supply-side constraints driving higher-than-expected inflation in core goods

and services

• Tightening labor market conditions with unemployment falling to 4.2%

• Emerging signs of stronger domestic cost and price pressures

• Risks of inflation expectations becoming de-anchored

The BOE continued its tightening cycle through 2022 and into 2023, with rates ultimately
peaking at 5.25% in August 2023, before beginning to cut rates in February 2025. This
aggressive tightening path demonstrated the BOE's commitment to bring inflation back to
target, even at the cost of slowing economic growth.

➢ Philippines: Bank of Philippines’ Response

By contrast, the BSP maintained an accommodative monetary policy stance for much longer
despite emerging inflationary pressures. As outlined in its February 2022 Monetary Policy
Report, the BSP held its key policy rate at 2.0% for the overnight reverse repurchase (RRP)
facility, with corresponding rates for overnight deposit and lending facilities at 1.5% and 2.5%
respectively.

Despite inflation forecasts being revised slightly higher for 2022 and 2023, the BSP projected
the inflation path would remain within its 2-4% target range over the policy horizon. The BSP
was particularly focused on supporting economic recovery, noting:
 1. Growth prioritization: The BSP emphasized that "preserving ongoing policy support
remains a priority given the uncertainty over domestic economic prospects" and the
risks surrounding global food and oil prices.

2. Supply-side inflation view: Unlike the BOE, the BSP characterized higher inflation as
primarily reflective of "trends in the international commodities market" and
emphasized that "domestic supply-side price pressures are being actively addressed
through direct non-monetary measures."

3. Gradual normalization approach: The BSP indicated it was refining its "timeline and
strategy for the gradual exit from pandemic-related measures and accommodative
policy settings," with particular attention to "normalization of monetary conditions
prior to the eventual tightening."

These policy differences highlight the BSP's greater willingness to look through supply-side
inflation, focusing instead on supporting economic recovery while relying on non-monetary
measures to address supply constraints. This approach reflected the Philippines' different
economic context:

• The economy had not yet fully recovered to pre-pandemic output levels

• Labor markets still showed significant slack compared to the UK

• Monetary transmission mechanisms differ between advanced and emerging economies

• The Philippines' greater vulnerability to external factors and lower fiscal capacity
Effectiveness of Monetary Policy Responses

➢ Bank of England

The BOE's more aggressive tightening proved partially successful in containing inflation,
though at significant economic cost. UK inflation eventually peaked at 11.1% in October 2022
before declining to 1.7% by September 2024. However, inflation subsequently ticked back up
to 3.0% by January 2025, remaining persistently above target.

Several factors affected the efficacy of the BOE's approach:

1. Monetary policy transmission: The high proportion of fixed-rate mortgages

(approximately 80% by value) delayed the full impact of rate increases on the housing
market and consumer spending.

2. Labor market resilience: Despite tighter monetary policy, the UK labor market
remained robust, with continued wage pressures contributing to persistent services
inflation.

3. External factors: Global energy and food price shocks were largely beyond the BOE's
control, limiting the effectiveness of domestic monetary policy.

➢ Bank of Philippines

The BSP's more gradual approach reflected its different prioritization of risks, focusing on:

1. Avoiding economic scarring: The BSP explicitly noted that "domestic monetary policy
support along with expansionary fiscal policy will continue to help spur domestic
demand and mitigate the extent of economic scarring that could affect the growth
trajectory over the long term."

2. Supporting financial stability: The BSP monitored "potential risks to future inflation"
while ensuring that "the expansion of money and credit amid the low interest
environment will not lead to excessive inflation pressures nor trigger financial stability
risks."

3. Output gap considerations: The BSP's Policy Analysis Model projected the output
gap to close and turn positive only in H2 2022, supporting its view that demand-driven
inflation pressures remained limited.
However, this accommodative stance eventually proved insufficient as inflation pressures
intensified. Like many central banks that maintained accommodative policies longer, the BSP
was ultimately forced to accelerate rate hikes as inflation expectations became less well-
anchored.
Policy Coordination and Supply-Side Measures (following on from ‘Introduction’)

A notable difference between the two central banks was the emphasis on policy coordination
and non-monetary measures:

• The BSP placed greater emphasis on "direct non-monetary measures" to address supply
shortfalls of key commodities and emphasized the need to "refine these measures as
needed."

• Both central banks emphasized the need to avoid second-round effects, with the BSP
highlighting "the importance of remaining vigilant in implementing measures that
could help avoid second round effects in terms of fare hikes and undue wage
adjustments."

• The BSP's communications emphasized the role of fiscal support, while the BOE was
more focused on its independent mandate to control inflation.

(above chart shows Meralco an energy company in Philippines illustrating a key

supply-side factor which here is “energy prices” that the BSP was monitoring)