What Is the Phillips Curve: Inflation, Unemployment, and the Trade-Off

What Is the Phillips Curve?

The Phillips Curve is a macroeconomic concept describing an empirical inverse relationship between the rate of unemployment and the rate of inflation in an economy: as unemployment falls, inflation tends to rise, and as unemployment rises, inflation tends to fall. The implication — that policymakers face a trade-off between achieving low unemployment and maintaining low inflation — made the Phillips Curve one of the most influential and contested ideas in 20th-century macroeconomics.

The relationship was first documented systematically by New Zealand economist A.W. (Alban William) Phillips in a 1958 paper published in the journal Economica, in which he examined the statistical relationship between wage inflation and unemployment in the United Kingdom from 1861 to 1957. Phillips found a stable, downward-sloping curve fitting the data remarkably well. American economists Paul Samuelson and Robert Solow extended the analysis to the United States in 1960, framing the curve in terms of the price inflation–unemployment trade-off and giving it widespread policy relevance.

Original Phillips Curve

In the original formulation, the Phillips Curve suggested that policymakers could choose any point on the curve by adjusting macroeconomic policy:

• To reduce unemployment below its current level, policymakers could accept higher inflation by expanding demand (through fiscal stimulus or easier monetary policy).
• To reduce inflation, policymakers could accept higher unemployment by contracting demand (through fiscal tightening or tighter monetary policy).

This framework gave Keynesian policymakers a practical tool for managing the macroeconomy: the curve appeared to offer a menu of sustainable combinations of inflation and unemployment from which to choose, based on social priorities.

The 1970s Challenge: Stagflation

The apparent stability of the Phillips Curve was dramatically challenged in the late 1960s and especially the 1970s, when many developed economies experienced stagflation — simultaneously high inflation and high unemployment — something the original Phillips framework suggested should be impossible. The 1973 and 1979 oil price shocks contributed to supply-side inflation while unemployment also rose, blowing up the apparent trade-off.

This empirical failure prompted fundamental theoretical revisions. The primary response came from economists Milton Friedman and Edmund Phelps, who independently proposed the concept of the expectations-augmented Phillips Curve and the natural rate of unemployment.

The Expectations-Augmented Phillips Curve

Friedman (1968) and Phelps (1967–1968) argued that the original Phillips Curve had omitted a crucial variable: inflationary expectations. Workers and firms make wage and price decisions based partly on their expectations of future inflation. If workers expect higher inflation, they will demand higher wages, and firms will set higher prices — generating inflation independently of unemployment.

The Friedman-Phelps model implied that the long-run Phillips Curve is vertical, not downward-sloping. In the long run, workers and firms will adjust their expectations to actual inflation, and the economy will return to the natural rate of unemployment (also called the Non-Accelerating Inflation Rate of Unemployment, or NAIRU) regardless of the inflation rate. The trade-off between inflation and unemployment is only temporary (short-run); attempts to maintain unemployment below the natural rate will generate ever-accelerating inflation.

The NAIRU

The NAIRU is the unemployment rate at which inflation is stable — neither accelerating nor decelerating. If unemployment falls below the NAIRU, inflation will rise; if it rises above the NAIRU, inflation will fall. The NAIRU is not fixed; it can shift over time due to changes in labor market institutions, demographics, productivity, and technology.

Short-Run vs. Long-Run Phillips Curve

The New Keynesian Phillips Curve

Modern macroeconomic models use the New Keynesian Phillips Curve (NKPC), which relates current inflation to expected future inflation and the current output gap (the difference between actual and potential output). Unlike the original backward-looking formulation, the NKPC incorporates rational expectations and staggered price setting (firms do not all adjust prices simultaneously). This framework forms the backbone of Dynamic Stochastic General Equilibrium (DSGE) models used by central banks worldwide.

The Flattening Phillips Curve

From the 1990s through the mid-2010s, central banks and economists observed that the Phillips Curve appeared to have flattened — inflation became less responsive to changes in unemployment than it had been in earlier decades. Several explanations were proposed:

• Improved central bank credibility (inflation expectations well-anchored)
• Globalization suppressing wage and price inflation
• Increased productivity growth
• Changes in labor market structure

This flattening posed challenges for monetary policymakers trying to gauge inflationary pressures.

Post-2021 Resurgence

The sharp rise in inflation beginning in 2021–2022 — driven by pandemic-era supply disruptions, massive fiscal stimulus, and pent-up demand — renewed debate about the Phillips Curve's continued relevance. The Federal Reserve and other central banks raised interest rates rapidly to cool inflation by increasing unemployment and reducing demand, explicitly invoking Phillips Curve logic in their policy communications. The subsequent disinflation achieved without a severe recession in the United States sparked debate about whether the curve had re-steepened or whether the inflation episode was primarily supply-driven rather than demand-driven.

Conclusion

The Phillips Curve has had a turbulent intellectual history — from celebrated empirical regularity to apparent collapse to theoretical rehabilitation and ongoing debate. Its central insight — that inflation and unemployment are connected through demand pressures and expectations — remains a cornerstone of macroeconomic policy thinking, even as economists continue to debate the precise shape, stability, and determinants of the relationship across different economic environments.