What is the Phillips Curve?
The Phillips curve is an economic concept developed by A. W. Phillips stating that inflation and
unemployment have a stable and inverse relationship. The theory claims that with economic
growth comes inflation, which in turn should lead to more jobs and less unemployment. However, the
original concept has been somewhat disproven empirically due to the occurrence of stagflation in the
1970s, when there were high levels of both inflation and unemployment. 1 2
DEFINITION:
The Phillips curve depicts the relationship between inflation and unemployment rates.
Higher inflation is associated with lower unemployment and vice versa.
Understanding the Phillips Curve
The concept behind the Phillips curve states the change in unemployment within an economy has a
predictable effect on price inflation. The inverse relationship between unemployment and inflation is
depicted as a downward sloping, concave curve, with inflation on the Y-axis and unemployment on the X-
axis. Increasing inflation decreases unemployment, and vice versa. Alternatively, a focus on decreasing
unemployment also increases inflation, and vice versa. 3
The belief in the 1960s was that any fiscal stimulus would increase aggregate demand and initiate the
following effects. Labor demand increases, the pool of unemployed workers subsequently decreases and
companies increase wages to compete and attract a smaller talent pool. The corporate cost of wages
increases and companies pass along those costs to consumers in the form of price increases.
On August 27, 2020 the Federal Reserve announced that it will no longer raise interest rates due to
unemployment falling below a certain level if inflation remains low. It also changed its inflation target to an
average, meaning that it will allow inflation to rise somewhat above its 2% target to make up for periods
when it was below 2%.4 5
The Phillips Curve and Stagflation
Stagflation occurs when an economy experiences stagnant economic growth, high unemployment and
high price inflation. This scenario, of course, directly contradicts the theory behind the Philips curve. The
United States never experienced stagflation until the 1970s, when rising unemployment did not coincide
with declining inflation.
the Long Run Phillips Curve
The long-run Phillips curve is a vertical line that illustrates that there is no permanent trade-
off between inflation and unemployment in the long run. However, the short-run Phillips
curve is roughly L-shaped to reflect the initial inverse relationship between the two variables.
As unemployment rates increase, inflation decreases; as unemployment rates decrease,
inflation increases.
Understanding the Phillips curve in light of consumer and worker expectations, shows that the relationship
between inflation and unemployment may not hold in the long run, or even potentially in the short run.
The Short-Run Phillips Curve
The short-run Phillips curve depicts the inverse trade-off
between inflation and unemployment.Contrast it with the
long-run Phillips curve (in red), which shows that over the long
term, unemployment rate stays more or less steady
regardless of inflation rate.
Consider the example shown in. When the unemployment rate
is 2%, the corresponding inflation rate is 10%. As
unemployment decreases to 1%, the inflation rate increases
to 15%. On the other hand, when unemployment increases to
6%, the inflation rate drops to 2%.
The Phillips curve is an economic concept developed by A. W. Phillips stating that inflation and
unemployment have a stable and inverse relationship. The theory claims that with economic
growth comes inflation, which in turn should lead to more jobs and less unemployment. However, the
original concept has been somewhat disproven empirically due to the occurrence of stagflation in the
1970s, when there were high levels of both inflation and unemployment. 1 2
DEFINITION:
The Phillips curve depicts the relationship between inflation and unemployment rates.
Higher inflation is associated with lower unemployment and vice versa.
Understanding the Phillips Curve
The concept behind the Phillips curve states the change in unemployment within an economy has a
predictable effect on price inflation. The inverse relationship between unemployment and inflation is
depicted as a downward sloping, concave curve, with inflation on the Y-axis and unemployment on the X-
axis. Increasing inflation decreases unemployment, and vice versa. Alternatively, a focus on decreasing
unemployment also increases inflation, and vice versa. 3
The belief in the 1960s was that any fiscal stimulus would increase aggregate demand and initiate the
following effects. Labor demand increases, the pool of unemployed workers subsequently decreases and
companies increase wages to compete and attract a smaller talent pool. The corporate cost of wages
increases and companies pass along those costs to consumers in the form of price increases.
On August 27, 2020 the Federal Reserve announced that it will no longer raise interest rates due to
unemployment falling below a certain level if inflation remains low. It also changed its inflation target to an
average, meaning that it will allow inflation to rise somewhat above its 2% target to make up for periods
when it was below 2%.4 5
The Phillips Curve and Stagflation
Stagflation occurs when an economy experiences stagnant economic growth, high unemployment and
high price inflation. This scenario, of course, directly contradicts the theory behind the Philips curve. The
United States never experienced stagflation until the 1970s, when rising unemployment did not coincide
with declining inflation.
the Long Run Phillips Curve
The long-run Phillips curve is a vertical line that illustrates that there is no permanent trade-
off between inflation and unemployment in the long run. However, the short-run Phillips
curve is roughly L-shaped to reflect the initial inverse relationship between the two variables.
As unemployment rates increase, inflation decreases; as unemployment rates decrease,
inflation increases.
Understanding the Phillips curve in light of consumer and worker expectations, shows that the relationship
between inflation and unemployment may not hold in the long run, or even potentially in the short run.
The Short-Run Phillips Curve
The short-run Phillips curve depicts the inverse trade-off
between inflation and unemployment.Contrast it with the
long-run Phillips curve (in red), which shows that over the long
term, unemployment rate stays more or less steady
regardless of inflation rate.
Consider the example shown in. When the unemployment rate
is 2%, the corresponding inflation rate is 10%. As
unemployment decreases to 1%, the inflation rate increases
to 15%. On the other hand, when unemployment increases to
6%, the inflation rate drops to 2%.
