Introduction to the Phillips Curve
The Phillips curve is a concept in economics that describes the relationship between unemployment rates and changes in money wages. This idea was first introduced by economist William Phillips, who observed that wages tend to rise faster when the unemployment rate is low. In other words, the Phillips curve suggests an inverse relationship between inflation and unemployment.
Understanding the Phillips Curve
The Phillips curve is based on the idea that when unemployment is low, companies will offer higher wages to attract high-quality workers away from other businesses. Conversely, when more people are unemployed, companies don’t need to compete as much with their salary offers, so the increase in worker wages will be slower. This concept was first presented in Phillips’ 1958 paper, "The Relation Between Unemployment and the Rate of Change of Money Wage Rates in the United Kingdom, 1861–1957."
The Research and Rationale Behind the Phillips Curve
Phillips discovered that changes in people’s wages could generally be explained by the level of unemployment, except during periods when the prices of imported goods increased sharply and suddenly. The main implication of the Phillips curve is that maintaining low unemployment and low inflation simultaneously may not be achievable in the long run. Unemployment rates inversely influence the rate of wage increases, which in turn affect the rate of inflation.
Challenges to the Phillips Curve
The Phillips curve concept was put into question in the 1970s, when the United States experienced "stagflation," a condition of high inflation and high unemployment. This suggested that the relationship between unemployment and inflation is more unstable than was assumed in the Phillips curve theory. Additionally, the U.S. experienced persistent low unemployment and relatively low inflation at the beginning of the 21st century, further disproving the inverse link between unemployment and inflation.
Factors Affecting the Relationship Between Inflation and Unemployment
There are several factors that can affect the relationship between inflation and unemployment, including supply shocks, inflationary expectations, and technological advancements. Some economists argue that the Phillips curve theory isn’t well thought out or even completely untrue, pointing to the 1970s period of stagnation and inflation as evidence.
Criticisms of the Phillips Curve
Some economists, particularly those who follow the Austrian school of economics, believe that the Phillips curve theory depends on mathematical assumptions, models, and predictions that don’t really link up with the basic forces that steer the economy. They argue that the theory isn’t dependable and that the relationship between unemployment and inflation is more complex than the Phillips curve suggests.
The Bottom Line
When taken at face value, the Phillips curve makes sense: as the supply and demand of labor (and the goods they produce) ebb and flow across economic cycles, pricing power shifts back and forth between employer and employee, which should theoretically drive prices. However, in the real world, employment and inflation are complex, with many contributing factors driving their overall levels in both the short term and long term.
Conclusion
In conclusion, the Phillips curve is a concept in economics that describes the relationship between unemployment rates and changes in money wages. While it may show a correlation between unemployment and inflation at times, this correlation isn’t necessarily causation, nor can it be expected to hold over longer periods. The relationship between inflation and unemployment is complex and influenced by many factors, making it difficult to predict or rely solely on the Phillips curve theory.
