The Phillips Curve

• Bill Phillips discovered a negative correlation between inflation and unemployment
• In the short run, there is a trade-off between inflation and unemployment
• In the long run, supply-side improvements are more effective in reducing unemployment

The Phillips curve, named after economist Bill Phillips, shows a negative correlation between inflation and unemployment. When inflation is high, it indicates an overheating economy operating at full capacity, leading to high demand for labor and lower unemployment rates. Conversely, during a downturn, with higher unemployment rates, there is less demand for labor, resulting in lower or negative inflation. However, this relationship only holds in the short run. In the long run, the Phillips curve is argued to be vertical at the non-accelerating inflation rate of unemployment (NIRU), also known as the natural rate of unemployment. This is because attempts to lower unemployment below the NIRU trigger accelerating inflation, pushing unemployment back to its natural level. The policy implications of the short run Phillips curve are that governments face a trade-off between inflation and unemployment. They can accept higher inflation to reduce unemployment or keep inflation low and accept higher unemployment. In the long run, the focus should be on supply-side improvements rather than demand-side policies. This would result in a leftward shift of the long run Phillips curve and a lower natural rate of unemployment.