Economics
The Phillips Curve: Inflation and Unemployment Trade-Off Today
Quick fact
In the 1970s, the U.S. experienced both high inflation and high unemployment — a combination the original Phillips curve said was impossible.
Why this is interesting
You've probably heard that when unemployment is low, prices rise — but is that trade-off really a law of economics? Imagine a seesaw that sometimes turns into a rollercoaster.
Read the full explanation
Understanding The Phillips Curve: Inflation and Unemployment Trade-Off Today
In the 1950s, economist A.W. Phillips plotted British data and noticed a pattern: when unemployment was low, wages (and prices) tended to rise quickly, and when unemployment was high, wage growth was slow. It seemed like a simple trade-off: low unemployment costs higher inflation, and low inflation costs higher unemployment. For a while, governments tried to use this trade-off to 'buy' lower unemployment by accepting a bit more inflation. The process works like this: when the government boosts spending or lowers interest rates, businesses hire more people, pushing unemployment down. As competition for workers increases, wages rise, and businesses pass those costs on to consumers, raising prices. That's the intuitive link between low unemployment and high inflation.
A deeper explanation
The simple Phillips curve relationship broke down in the 1970s when oil shocks sent inflation soaring while unemployment also rose — a phenomenon called stagflation. Economists like Milton Friedman and Edmund Phelps argued that the trade-off only holds in the short run when people are surprised by inflation. Once workers and businesses expect higher inflation, they build it into their wage demands and pricing, shifting the Phillips curve outward. In the long run, there is no trade-off: the economy returns to the 'natural rate of unemployment' regardless of inflation. Today, central banks target inflation, not unemployment, because they know that trying to push unemployment below its natural rate will only cause inflation to accelerate. The modern Phillips curve is therefore a relationship between inflation and the unemployment gap (actual minus natural), modified by inflation expectations and supply shocks. This explains why, despite low unemployment in recent years, inflation has not always surged as the old curve predicted — expections are well-anchored, and other factors like globalization and technology have muted price increases.