Phillips Curve [PC]

The Phillips Curve is a fundamental economic concept that illustrates the inverse relationship between unemployment and inflation rates in an economy. Named after economist A.W. Phillips who first observed this relationship in the United Kingdom (1861-1957), this curve suggests that as unemployment decreases, inflation tends to increase, and vice versa. The relationship occurs because when unemployment is low, workers have more bargaining power to demand higher wages, which leads businesses to raise prices to maintain profit margins. For example, during the late 1960s in the United States, unemployment fell to around 3.5% while inflation rose to over 5%. However, the Phillips Curve relationship broke down during the 1970s stagflation period, leading to the development of the expectations-augmented Phillips Curve. Modern central banks like the Federal Reserve use Phillips Curve analysis to understand the trade-offs between employment and price stability when setting monetary policy. The curve has ‘flattened’ in recent decades, meaning the relationship between unemployment and inflation has weakened, making monetary policy more challenging.