The Phillips Curve Study Pack
Kibin's free study pack on The Phillips Curve includes a 6-section study guide, 25 quiz questions, 30 flashcards, and 5 open-ended Explain review questions. Sign up free to track your progress toward mastery, plus upload your own notes and recordings to create personalized study packs organized by course.
Last updated May 28, 2026
The Phillips Curve Study Guide
Trace the Phillips Curve from A.W. Phillips's 1958 findings to Friedman and Phelps's expectations-augmented model, covering the short-run inflation-unemployment tradeoff, the vertical long-run curve, and how 1970s stagflation shattered the idea of a stable, exploitable relationship.
Key Takeaways
- •The Phillips Curve describes an inverse relationship between inflation and unemployment, suggesting that lower unemployment tends to coincide with higher inflation and vice versa.
- •The original short-run Phillips Curve was derived empirically by A.W. Phillips in 1958 from nearly a century of UK wage and unemployment data.
- •The short-run tradeoff breaks down over time because workers and firms adjust their inflation expectations, shifting the short-run Phillips Curve upward and producing a vertical long-run Phillips Curve at the natural rate of unemployment.
- •Stagflation in the 1970s — simultaneous high inflation and high unemployment — provided decisive real-world evidence against a stable, exploitable short-run Phillips Curve.
- •The expectations-augmented Phillips Curve, developed by Milton Friedman and Edmund Phelps, introduced the concept that only unexpected inflation can temporarily reduce unemployment below the natural rate.
- •Policymakers face a fundamental constraint: any attempt to permanently hold unemployment below the natural rate accelerates inflation without a lasting employment benefit.
Origins and the Empirical Relationship
The Phillips Curve emerged from an observation about macroeconomic data before it became a theoretical concept, and understanding its empirical roots is essential to evaluating both its usefulness and its limits.
A.W. Phillips and the 1958 Study
- •British economist A.W. Phillips analyzed roughly 100 years of data on wage inflation and unemployment in the United Kingdom, publishing his findings in 1958.
- •Phillips found that years of low unemployment consistently corresponded with faster wage growth, while years of high unemployment matched slower wage growth or even wage declines.
- •Economists in the United States quickly replicated the finding using price inflation rather than wage inflation, and the downward-sloping curve bearing Phillips's name entered mainstream macroeconomic analysis.
The Core Inverse Relationship
- •The logic behind the tradeoff rests on labor market tightness: when unemployment is low, employers compete for scarce workers, bidding up wages and passing higher labor costs into prices.
- •When unemployment is high, workers have less bargaining power, wage growth slows, and firms face less pressure to raise prices.
- •Graphically, the short-run Phillips Curve plots the unemployment rate on the horizontal axis and the inflation rate on the vertical axis, sloping downward from left to right.
Policy Implications of the Short-Run Phillips Curve
Once economists recognized the short-run tradeoff, policymakers treated the Phillips Curve as a menu of choices — a tool for deliberately selecting a preferred combination of inflation and unemployment through monetary or fiscal policy.
Demand-Side Policy and Movement Along the Curve
- •Expansionary monetary policy — such as the Federal Reserve increasing the money supply or cutting interest rates — raises aggregate demand, which draws more workers into employment but also pushes prices upward, moving the economy up and to the left along the short-run Phillips Curve.
- •Contractionary policy works in the opposite direction: tighter credit slows spending, firms hire less aggressively, unemployment rises, and inflation falls — a movement down and to the right along the curve.
- •This framing gave policymakers an apparent instrument: choose the inflation rate you are willing to tolerate and the corresponding unemployment rate will follow.
Limitations of Treating the Curve as a Stable Menu
- •The stable-menu interpretation assumes that the relationship between inflation and unemployment does not itself change when policy exploits it — an assumption that later proved incorrect.
- •It also treats inflation expectations as fixed, ignoring the fact that households and businesses update their behavior once they anticipate higher prices.
Expectations, the Natural Rate, and the Long-Run Phillips Curve
Milton Friedman and Edmund Phelps independently challenged the stable short-run tradeoff in the late 1960s by incorporating inflation expectations into the analysis, fundamentally changing how economists interpret the curve.
The Natural Rate of Unemployment
- •Friedman and Phelps argued that every economy has a natural rate of unemployment — the rate consistent with stable inflation — determined by structural features like job search frictions, skills mismatches, and labor market institutions rather than by aggregate demand.
- •At the natural rate, the labor market is in equilibrium: workers are not systematically fooled about real wages, and there is no built-in pressure for inflation to accelerate or decelerate.
The Expectations-Augmented Phillips Curve
- •The expectations-augmented Phillips Curve holds that actual inflation equals expected inflation plus a term reflecting how far unemployment deviates from its natural rate.
- •If policymakers use expansionary policy to push unemployment below the natural rate, workers initially accept the higher nominal wages without realizing inflation is eroding their real wages — unemployment falls temporarily.
- •Once workers revise their inflation expectations upward and demand higher wages to restore real purchasing power, the short-run Phillips Curve shifts upward, and unemployment returns to its natural rate at a permanently higher inflation rate.
The Vertical Long-Run Phillips Curve
- •In the long run, after expectations fully adjust, there is no tradeoff: the long-run Phillips Curve is a vertical line at the natural rate of unemployment.
- •This vertical curve means that sustained attempts to keep unemployment below the natural rate produce accelerating inflation with no lasting employment gain — a result known as the accelerationist hypothesis.
- •The only way to reduce the natural rate itself is through structural reforms — improving job training, reducing search frictions, or reforming labor market institutions — not through demand management.
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A.W. Phillips published his landmark study in 1958 after analyzing approximately how many years of UK wage and unemployment data?
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The Short-Run Phillips Curve
Explain the short-run Phillips Curve in your own words. What relationship does it describe, what is the logic behind that relationship, and how did A.W. Phillips originally discover it?
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