APMacro: Phillips Curve


Phillips Curve

We can demonstrate the short run tradeoff between the rate of inflation and the rate of unemployment through the Phillips Curve. The Phillips Curve is named after A.W. Phillips, who developed the idea in Great Britain. This curve suggests an inverse relationship between the rate of inflation and the rate of unemployment. Lower unemployment rates, measured as leftward movements on the horizontal axis, are associated with higher rates of inflation, measured as upward movements on the vertical axis.

Long Run Phillips Curve

The long-run Phillips Curve is now seen as a vertical line at the natural rate of unemployment, where the rate of inflation has no effect on unemployment.

Many economists believed that Phillips results showed that there was a permanently stable relationship between inflation and unemployment. One implication of this for government policy was that governments could control unemployment and inflation with a Keynesian policy. They could tolerate a reasonably high rate of inflation as this would lead to lower unemployment, there would be a tradeoff between inflation and unemployment. For example, monetary policy and/or fiscal policy could be used to stimulate the economy, raising gross domestic product and lowering the unemployment rate. Moving along the Phillips curve, would lead to a higher inflation rate, the cost of enjoying lower unemployment rates. Some economists argue that this view is historically false and this criticism is based on the United States’ experience during the 1970s, which had periods of high unemployment and high inflation at the same time. 

Arrows-02-june

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