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Phillips curvea curve depicting an empirical observation (based on the work of the British economist A. W. Phillips) of the relationship between the level of UNEMPLOYMENT and the rate of change of MONEY WAGES and, by inference, the rate of change of prices (INFLATION). Fig. 142 shows the rate of change of money wages/rate of inflation on the vertical axis and the rate of unemployment on the horizontal axis. The figure depicts an initial Phillips curve 1. Point X, where the Phillips curve intersects the horizontal axis, is the rate of unemployment consistent with stable prices - the so-called ‘non-accelerating inflation rate of unemployment’ (NAIRU), also referred to as the ‘NATURAL RATE OF UNEMPLOYMENT’. At levels of unemployment below point X, the inflation rate then starts to increase. Let us assume that initially the current rate of unemployment is A and that the current rate of inflation is C.
A fall in unemployment (from A to B in Fig. 142), resulting from an increase in the level of AGGREGATE DEMAND, brings about an acceleration in the rate of increase of money wages (from C to D), reflecting employers’ greater willingness to grant wage increases as the demand for their products expands. By contrast, rising unemployment and falling demand lead to a slowing down in the rate of increase of money wages. The ‘curve’ thus suggests that there is an inverse relationship (a ‘trade-off) between unemployment and DEMAND-PULL INFLATION. However, while there was strong empirical support for the Phillips curve relationship in the past, in the 1980s high unemployment and high inflation tended to co-exist (see STAGFLATION). This led to attempts to reformulate the Phillips curve to allow, for example, for the effect of price expectations on money wage increases. See EXPECTATIONS-ADJUSTED/AUGMENTED PHILLIPS CURVE.
More recently, the UK economy has experienced both lower unemployment and lower inflation, i.e. the Phillips curve has shifted inwards towards the origin and become less steep (Phillips curve 2 in Fig. 142). The explanation for this, it is suggested, is because of greater labour market flexibility, which has reduced ‘the natural rate of unemployment’ (to point Y in the figure) while a more stable monetary climate, through the government's commitment to an inflation rate target of no more than 2%, has reduced inflationary expectations. See OPTIMIZING,FIXED TARGETS, NEW AND OLD PARADIGM ECONOMICS.