What Is Phillip’s Curve

Phillips Curve is an economic concept developed by A. W. Phillips argues that inflation and unemployment have an inverse and stable relationship. The theory is that economic growth is accompanied by inflation, leading to increased job creation and reduced unemployment. However, the original concept has been somewhat challenged by the inflation of the 1970s, when there were high levels of both inflation and unemployment. Phillips did not explicitly claim a link between unemployment and inflation; rather, this conclusion was derived from his statistical data. The Phillips Curve implications are valid only in the short term. It fails to justify when the economy is experiencing stagflation or when unemployment and inflation are significantly high.

Important facts about the Phillip’s Curve

• According to the Phillips Curve, inflation and unemployment are inversely related. Inflationary pressures are linked to decreased unemployment and vice versa.
• The Phillips Curve was a notion used to drive macroeconomic stability in the twentieth century, but stagflation in the 1970s cast doubt on it.
• Studying the Phillips Curve given consumers and employee expectations reveals that the long-term, and even potentially short-term, relationship between unemployment and inflation may not hold.

These were some important facts about Phillip’s Curve.

Graphical Representation of Phillip’s Curve

The significance of Phillip’s Curve is that the change in unemployment in the economy has a predictable effect on inflation. Graphical Representation of Phillip’s Curve presents inflation on the Y-axis and unemployment on the X-axis; the inverse correlation of unemployment and inflation is illustrated as a downward sloping, concave Curve. According to the Graphical Representation of Phillip’s Curve, Inflationary pressures reduce unemployment and vice versa. Focusing on lowering unemployment, on the other hand, raises inflation, and vice versa. In the 1960s, it was widely assumed that any stimulus spending would boost spending and trigger the following effects. As labour demand rises, jobless people shrink, forcing employers to raise salaries to compete for a smaller skilled workforce. The cost of corporate salaries rises, and corporations pass those expenses on to consumers in terms of price hikes. This belief system has led many governments to adopt a “stop-go” strategy in the form of targeted inflation, and monetary and fiscal policies were used to expand or contract the economy to achieve the target. However, stable trade between inflation and unemployment collapsed in the 1970s with rising inflation, leading to doubts about the legitimacy of the Phillips Curve. It is all about the graphical representation of Phillip’s Curve.

Significance of Phillip’s Curve

Since Phillips Curve was overly simplistic, most economists don’t use it in its original form. A quick examination of US unemployment and inflation data from 1953 to 1992 reveals this. 

Modified versions of the Phillips Curve that account for inflationary expectations are still popular today. Although the theory is known by various names and has minor differences in details, all recent forms distinguish between long- and short-term unemployment effects. According to Edmund Phelps and Milton Friedman, the “short term Phillips Curve” is also known as the “expectations-augmented Phillips Curve” since it shifts higher when inflation expectations rise. This means that, in the long term, monetary policy does not affect unemployment, which returns to its “natural rate. This long-term “neutrality” of monetary policy, on the other hand, allows for short term volatility and the monetary authority’s power to reduce unemployment by boosting eternal inflation temporarily, and vice versa. Blanchard’s popular textbook presents the expectations-augmented Phillips Curve in textbook form.

Stagflation and Phillips Curve

Many countries had high levels of unemployment and inflation in the 1970s, a phenomenon known as stagflation. Phillips Curve indicated it could not happen, and several scholars, led by Milton Friedman, launched a determined attack on the Curve. Friedman claimed that Phillip’s Curve correlation was a one-time occurrence. He suggested that, in the long term, employers and employees will consider the inflation context, resulting in employment agreements that increase pay at rates close to projected inflation. Unemployment would subsequently begin to climb again but faster due to increasing inflation rates. This finding suggests no trade-off between unemployment and inflation in the long run. This has practical implications, as it indicates that central banks should not set unemployment objectives lower than the natural rate.

Conclusion

Wages and prices have a back-and-forth relationship. Wages are one of the most important components of a company’s cost of production that determines product prices. On the other hand, prices impact the cost of living. Therefore they also control salaries. Phillips Curve focuses simply on the effect of wages on prices, ignoring the effect of prices on wages. That is its limitation because rising prices raise the cost of living, which leads to an increase in wages. Also, the Phillips Curve concept argues that inflation is a country’s internal problem tied to the domestic labour market, even though inflation in modern times is a global phenomenon.