Phillips curve

The Phillips curve is a single-equation empirical model, named after A. W. Phillips, describing a historical inverse relationship between rates of unemployment and corresponding rates of inflation that result within an economy. Stated simply, decreased unemployment, (i.e., increased levels of employment) in an economy will correlate with higher rates of inflation.

While there is a short run tradeoff between unemployment and inflation, it has not been observed in the long run. In 1968, Milton Friedman asserted that the Phillips curve was only applicable in the short-run and that in the long-run, inflationary policies will not decrease unemployment. Friedman then correctly predicted that, in the 1973–75 recession, both inflation and unemployment would increase. The long-run Phillips curve is now seen as a vertical line at the natural rate of unemployment, where the rate of inflation has no effect on unemployment. Accordingly, the Phillips curve is now seen as too simplistic, with the unemployment rate supplanted by more accurate predictors of inflation based on velocity of money supply measures such as the MZM ("money zero maturity") velocity, which is affected by unemployment in the short but not the long term.

William Phillips, a New Zealand born economist, wrote a paper in 1958 titled The Relation between Unemployment and the Rate of Change of Money Wage Rates in the United Kingdom, 1861-1957, which was published in the quarterly journal Economica. In the paper Phillips describes how he observed an inverse relationship between money wage changes and unemployment in the British economy over the period examined. Similar patterns were found in other countries and in 1960 Paul Samuelson and Robert Solow took Phillips' work and made explicit the link between inflation and unemployment: when inflation was high, unemployment was low, and vice versa.

In the 1920s, an American economist Irving Fisher noted this kind of Phillips curve relationship. However, Phillips' original curve described the behavior of money wages.

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