Phillips Curve
Candlefocus EditorThis concept is often assumed to hold true, as it helps policymakers explain macroeconomic policy outcomes related to inversely related increased inflation and decreased unemployment. When inflation falls and unemployment rises, policymakers turn to the Phillips curve to explain the shift in policy outcomes.
But, while the Phillips curve is widely accepted and often relied upon, it is not without its critics. This is especially true when it comes to long-term implications of the Phillips curve, as skepticisms have been raised over the past century.
The core of the criticism against the Phillips curve rests upon the idea of expectations. The relationship between inflation and unemployment as proposed by the Phillips curve is not static; it shifts depending on what consumers and workers are expecting. If workers expect their wages to go up, for example, then employers may have to pay more for labor, thereby decreasing unemployment and driving inflation.
One of the most popular theories regarding the Phillips Curve is the “expectations-augmented” Phillips Curve, which suggests that the relationship between inflation and unemployment occurs when economic agents, such as consumers and workers, adapt their behavior to the existing economic environment. In this sense, agents may make decisions that optimize their utility in the present, expecting prices and wages to change in the future. As a result, the expectations-augmented Phillips Curve intuits that the expected rate of inflation is the most influential factor in the relationship between inflation and unemployment.
The Phillips Curve became less useful in the 1970s when economists simultaneously grappled with high inflation and high unemployment—what’s commonly referred to as “stagflation.” Stagflation upended macroeconomic policymaking and saw the Phillips curve become increasingly less useful as an explanation.
In the end, while the Phillips curve is a good way to think about the relationship between inflation and unemployment in the present, it may not hold true in the long-term or the short-term. It is important to understand how consumer and worker expectations produce a dynamic and changing relationship between inflation and unemployment when developing macroeconomic policies. This way, decision makers can create more effective policies that are better suited to successfully guide economic growth.