What is the Phillips Curve?

The Relationship Between Unemployment & Inflation

The Phillips Curve aims to plot the relationship between inflation and unemployment. It was first put forward by British Economist, AW Phillips.

Philips theorized that inflation and unemployment have a predictable and inverse relationship. Meaning as inflation rises, unemployment falls and vice versa.

The theory goes that as the economy grows, it adds more jobs which leads to a reduced unemployment rate. Then as the labor market tightens and the competition for labor rises, wages rise as well. With increased wages comes increased demand for goods and services which leads to higher prices AKA inflation.

This relationship is demonstrated by the “Phillips Curve” illustrated below.

On the horizontal axis we have unemployment and on the verticle axis, we have inflation.

When unemployment is near zero (the left-hand side of the horizontal axis) inflation should be very high (near the top of the verticle axis).

When unemployment is very high (the right-hand side of the horizontal axis) inflation should be low. In theory, if unemployment is high enough we might actually see negative inflation, which economists refer to as “deflation”.