Phillips Curve

The idea is named after economist A. W. Phillips, who in 1958 showed that in the United Kingdom, periods of low unemployment had tended to coincide with faster wage growth. The logic is that when workers are scarce, employers must offer higher wages, and businesses pass these costs on through higher prices.

For a time, some policymakers believed they could choose a combination, accepting a little more inflation to achieve lower unemployment. But in the 1970s, many economies experienced high inflation and high unemployment at the same time, known as stagflation, which challenged this view.

Economists Milton Friedman and Edmund Phelps argued that the trade-off is only temporary. Once people come to expect higher inflation, they build it into wage demands, and unemployment returns to its natural rate. This led to the idea of an expectations-augmented Phillips curve.

The relationship has appeared weak in some periods, a pattern sometimes called a flat Phillips curve. Central banks still consider labour market tightness when forecasting inflation, but recognise that expectations and supply shocks also matter.