Phillips curve

The Phillips Curve is an economic model, named after New Zealand economist William Phillips. The graphical model displays the relationship between unemployment and inflation.[1] The model has had an important influence on academic economic debates over monetary policy.

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The Model

Phillips' model was build upon the novel application of proportional–integral–derivative control theory, which he had gained knowledge of during his time as an engineer, to economics.[2] When originally conceived, William Phillips' model only displayed the relationship between employment and wage growth.[3] Based on real world observations of the British economy, Phillips' model predicted that when employment was low, wages would stagnate or even fall. As employment fell, the pace of wage growth would accelerate. Later economists recognized the implication the model had regarding the potential relationship between inflation and unemployment. In the 1950s and 60s, it was believed that inflation could be managed in a way that could permanently lower the rate of unemployment, and by extension increase output. Milton Friedman, amongst others, argued against this position and was later vindicated by the experience of the American economy in the 1970s.[4][5]

Short-run Phillips curve

The Phillips curve exists in two separate models. Friedman argued that the trade-off between employment and inflation only existed in the short-run model.[6] Over a short period of time, a central bank can lower unemployment and increase real output by injecting liquidity into an economy at the cost of some additional inflation, but in the long run the price level will increase and the economy will return to its long-run trajectory.[note 1]

Long-run Phillips Curve

Economists like Friedman and Edmund Phelps argued that there was no trade-off between inflation and employment in the long run. Inflation would ultimately only increase the price level and have no significant impact on other real variables (consumption, investment, production). The assumptions of the basic model predicted that high inflation and unemployment cannot occur simultaneously. This was shown to be untrue when both high inflation and unemployment hit the American economy in the 1970s.

Although somewhat more controversial, economists have largely stood by both the modern short- and long-run variants.[7]

See Also

The Relationship Between Output, Employment, and Prices

Notes
  1. Rational expectation models predict that only unanticipated injections can achieve this. If markets anticipate a monetary injection the stimulus will only increase the price level. Additionally, empirical evidence on this is mixed. Real growth may not always "fade out" over the long run and a central bank can in fact get something for nothing. Naturally, a central bank can't do that forever as markets catch on.
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References
  1. Hoover, Kevin D. Phillips Curve EconLib
  2. Bollard, Alan "A Few Hares to Chase: The Economic Life and Times of Bill Phillips"
  3. A. W., Phillips. (1958). "The Relation between Unemployment and the Rate of Change of Money Wage Rates in the United Kingdom, 1861-1957"
  4. ibid.
  5. Chappelow, Jom. "Phillips Curve" Investopedia. May 1, 2019. Retrieved Feb 17, 2020.
  6. Friedman, Milton (1968). "The Role of Monetary Policy". American Economic Review. 58 (1): 1–17.
  7. Gordon, R. J. (2013). The Phillips curve is alive and well: Inflation and the NAIRU during the slow recovery (No. w19390). National Bureau of Economic Research.
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