Phillips Curve

What Is the Phillips Curve?

The Phillips Curve is an economic model describing an inverse relationship between the unemployment rate and inflation. In 1958, economist A. W. Phillips studied how wage growth in the United Kingdom related to unemployment over many decades and found that periods of low unemployment tended to coincide with faster wage increases. Later economists, including Paul Samuelson and Robert Solow, applied the idea to price inflation, suggesting policymakers could choose among different combinations of inflation and unemployment along the curve.

How It Works

When demand for workers is strong and unemployment is low, employers compete for staff, which pushes up wages. Businesses often pass higher labor costs on to customers through higher prices. When the economy is weak and unemployment is high, wage and price pressure tends to ease. The curve is usually drawn with unemployment on the horizontal axis and inflation on the vertical axis, sloping downward from left to right.

Why the Relationship Changed

In the late 1960s, Milton Friedman and Edmund Phelps argued that the trade-off holds only in the short run, because workers and businesses adjust their expectations about inflation over time. Once expectations catch up, unemployment tends to return to a level often called the natural rate of unemployment, and attempts to keep it lower mainly raise inflation. The 1970s, when high inflation and high unemployment occurred together, a condition known as stagflation, challenged the simple version of the curve.

Why It Matters to Investors

The curve helps explain how markets anticipate decisions on monetary policy by a central bank, which in turn influence interest rates and bond yields. Investors often watch inflation and employment data together because the balance between them shapes policy. Economists still debate how reliable the curve is, and many treat it as a useful framework rather than a fixed law.