Photo by Kaleidico on Unsplash
The Phillips Curve represents the inverse relationship between unemployment and inflation. So, as inflation rises unemployment should go down, and vice versa. The Phillips Curve was named after its creator, A.W. Phillips, who developed the concept in 1958.
We’ll consider the Phillips curve through the short-run and the long-run lens; first note the short-run implication of the curve that when inflation rises, unemployment falls, and when inflation decreases, unemployment rises:
Phillips Curve
The idea backing the Phillips Curve is that when inflation is high, consumers have less purchasing power and feel a need to work more, thus raising the labor force participation rate (note my article on the subject here) and producing an unemployment crunch should the job market not accommodate an influx of demand.
When inflation is low, consumers can afford more, and in terms of purchasing power compared to income or income growth (ceteris paribus) are better off. Thus, fewer individuals have to work or try to find work.
When consumer expectations of inflation or deflation shift. If people expect inflation to rise, they may seek higher wages, leading a wage-price spiral whereas actual inflation exceeds expectations. Generally, if inflation expectations rise, the short-run Phillips Curve shifts upward, signifying that inflation is higher at every level of unemployment.
Short-Run Shifts of the Phillips Curve
Over the short run, not just expectations incur shifts, but also demand-pull inflation and supply shocks. Let’s break that down, first looking at these 3 graphs:
Phillips Curve Rightward Short-Run Shifts
These graphs illustrate the three short-run shifts in respective scenarios where there’s an increase in aggregate demand (thus driving inflation up), there’s a supply shock (also driving up inflation), or there’s expectation of higher inflation, which as just discussed raised the actual level of inflation. In all cases, the short-run shift moves the Phillips Curve rightward, meaning that unemployment will be higher at every given level of inflation (basically: it gets worse).
This applies to the inverse; if there’s a demand shock and inflation slows down, the Phillips curve will shift to the left, and so on.
Now, what about the long-run?
Long-Run Shifts in the Phillips Curve
Over the long run, structural factors and the natural rate of unemployment affects the Phillips Curve; take specifics like policy changes, long-term central bank inflation targeting, and any other core, structural economic change.
Phillips Curve Long-Run Shifts.
In these cases, the central bank lowering its long-term inflation target means that for each given level of inflation, unemployment will be lower, while the natural rate of unemployment increasing (we’re assuming that technological advancement raises the natural rate of unemployment), then for each given level of inflation, unemployment will be higher.
We’ve now defined and explored the Phillips curve and its core relationship, as well as short-run and long-run shifts.
Hope you found that helpful! Here’s another article detailing nominal and real GDP (here), and one more about how to calculate inflation using multiple GDP deflators (here). Also:
Read about the Income Approach to GDP here.Read more economics stories here.To learn more about the oil market, consider reading about PADD Districts, the Why WTI and Brent are Crude Oils, and Why There are Price Differences Among Crude Oils, and my Oil & Gas Terms Guide.