Phillips Curve

Definition

The Phillips curve is an economic model that demonstrates the inverse relationship between the rate of unemployment and the rate of inflation in an economy. It suggests that as unemployment decreases, inflation tends to increase, and vice versa.

5 Must Know Facts For Your Next Test

1. The Phillips curve was developed by New Zealand economist A.W. Phillips, who observed the inverse relationship between unemployment and wage inflation in the United Kingdom from 1861 to 1957.
2. The Phillips curve suggests that policymakers face a trade-off between inflation and unemployment, known as the 'inflation-unemployment trade-off'.
3. The shape and position of the Phillips curve can shift over time due to factors such as changes in productivity, expectations, and the structure of the labor market.
4. The Phillips curve has been criticized for not accounting for the role of expectations in the relationship between inflation and unemployment, leading to the development of the 'expectations-augmented Phillips curve'.
5. The Phillips curve has important implications for monetary policy, as central banks often use it to guide their decisions on interest rates and other policy tools to achieve their inflation and employment targets.

Review Questions

• Explain the historical context and development of the Phillips curve concept.
  • The Phillips curve was developed by New Zealand economist A.W. Phillips, who observed an inverse relationship between the rate of unemployment and the rate of wage inflation in the United Kingdom from 1861 to 1957. Phillips' findings suggested that as unemployment decreased, wage inflation tended to increase, and vice versa. This relationship was later expanded to include the relationship between unemployment and price inflation, rather than just wage inflation, and became known as the 'Phillips curve'.
• Describe the key features of the Phillips curve and how it relates to the historical picture of inflation.
  • The Phillips curve demonstrates the inverse relationship between the rate of unemployment and the rate of inflation in an economy. It suggests that as unemployment decreases, inflation tends to increase, and vice versa. This trade-off between inflation and unemployment has important implications for policymakers, as they must balance their goals of achieving low inflation and low unemployment. The shape and position of the Phillips curve can shift over time due to factors such as changes in productivity, expectations, and the structure of the labor market, which is crucial for understanding the historical picture of inflation in an economy.
• Analyze the role of the Phillips curve in guiding monetary policy decisions and their impact on the historical picture of inflation.
  • The Phillips curve has important implications for monetary policy, as central banks often use it to guide their decisions on interest rates and other policy tools to achieve their inflation and employment targets. By understanding the relationship between unemployment and inflation, as depicted by the Phillips curve, policymakers can make more informed decisions on how to adjust monetary policy to balance their objectives. For example, if the economy is experiencing high inflation and low unemployment, the central bank may choose to raise interest rates to cool down the economy and bring inflation under control. Conversely, if the economy is facing high unemployment and low inflation, the central bank may opt to lower interest rates to stimulate economic activity and reduce unemployment. The historical picture of inflation in an economy is significantly influenced by the way policymakers have used the Phillips curve to guide their monetary policy decisions over time.

Related terms

Unemployment Rate: The percentage of the total labor force that is unemployed but actively seeking employment and willing to work.

Inflation Rate: The rate at which the general price level of goods and services in an economy increases over time.

Aggregate Demand: The total demand for all goods and services in an economy at a given time and price level.