Phillips Curve


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Phillips Curve

A graph that supposedly shows the relationship between inflation and unemployment. It is conjectured that there is a simple trade-off between inflation and unemployment (high inflation and low unemployment, and low inflation and high unemployment). Named after A.W. Phillips. Obviously, the relation between these important macroeconomic variables is more complicated than this simple graph would suggest. For a modern treatment, see work of Robert Lucas.

Phillips Curve

A curve postulating an inverse relationship between inflation and unemployment. That is, the Phillips curve theorizes that when inflation is low, unemployment is high and vice versa. This was a predominant theory for much of the mid-20th century until stagflation (high unemployment and high inflation) began to occur in the 1970s. Few economists use the Phillips curve today though it is a component in Gordon's triangle model.
Phillips curveclick for a larger image
Fig. 142 Phillips curve.

Phillips curve

a 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.

References in periodicals archive ?
Summershave toppled the belief that the Phillips curve has a substantial slope.
The slope of the Phillips curve is just a little bit flatter in the later estimation: The unemployment rate has a slightly smaller influence on inflation circa 2017 than it did circa 1999, though the influence of the unemployment rate on inflation was already small in the late 1990s.
In a total contradiction of the Phillips Curve, in Japan massive doses of central bank liquidity have resulted in the collapse of both consumer and financial asset prices.
Questions are also being raised regarding the short-run and long-run validity of the Phillips curve including its stability.
Changes in labour markets, work contracts and wage-setting processes, benefiting from the reforms introduced in previous years, which could imply a structural break in the Phillips curve," are likely factors, according to the minutes.
Substituting the Phillips curve into Kiley and Roberts's Taylor rule yields
Looking at more recent data for the Phillips curve --the curve that relates the unemployment rate and wage growth--we find strong evidence of wage rigidity.
These challenges are (i) a weakening Phillips curve relationship that can lead to arguments for a more intense focus on inflation relative to the orthodox view; (ii) very low real interest rates that can undermine the part of the orthodox view that claims monetary policy is very accommodative today; and (iii) citation of ongoing globalization as a possible reason to heed foreign economic developments distinctly and separately when making domestic monetary policy decisions.
The Phillips Curve is dead but still lives on in Fed models: unemployment has fallen from 10 percent to 5 percent, but inflation has remained less than 2 percent.
Fifth, some studies have highlighted that the Phillips curve has become flatter following the introduction of inflation targeting.
The theoretical basis of linear Taylor rule rests on two key assumptions, namely that central banks have quadratic loss function and that the Phillips curve is linear.
But Friedman (1968) also framed an argument for a downward-sloping short-run Phillips curve with a negative trade-off between inflation and unemployment, which became vertical in the long run.