Phillips Curve
The Phillips curve describes a short-run inverse relationship between unemployment and inflation: when unemployment is low, inflation tends to rise, and vice versa. The trade-off broke down in the 1970s, when high inflation and high unemployment occurred together.
Central banks constantly weigh jobs against prices. The Phillips curve is the classic model behind that trade-off: a hot labour market pushes wages and prices up, a weak one pulls them down. The idea has been challenged and revised, but it still shapes how markets read jobs data. This entry explains the curve, its history and why it matters for rates.
- Category
- Fundamentals and Macroeconomics
- Reading time
- 3 min
- Also called
- Inflation-unemployment trade-off, Expectations-augmented Phillips curve
- Updated
The Phillips curve in plain words
The Phillips curve shows the short-term relationship between unemployment and inflation in an economy.1
It suggests an inverse relationship: lower unemployment comes with higher inflation.1
Stagflation — high inflation, slow growth and steadily high unemployment — showed the trade-off can break down.2
How the Phillips curve logic works, step by step
Unemployment falls
Workers become scarce. See JOLTS.
Wages rise
Employers compete for staff. See Average Hourly Earnings.
Costs pass to prices
Inflation picks up. See Inflation.
Central bank reacts
Rates rise to cool demand. See Federal Reserve.
Unemployment rises
Inflation eases.
Expectations matter
If people expect inflation, the trade-off shifts.
Worked examples
Example 1 — A tight labour market
Trade-offUnemployment falls from 5% to 3.5%; core inflation rises from 2% to 3%.
| Unemployment | −1.5 points |
| Inflation | +1 point |
Lower unemployment alongside higher inflation fits the curve's inverse relationship.1
Example 2 — Stagflation
StagflationUnemployment 8% and inflation 10% at the same time.
| Both high | Curve breaks down |
Stagflation combines high inflation with steadily high unemployment, contradicting the simple trade-off.2 See Stagflation.
Example 3 — Market reaction
Hawkish readA jobs report shows unemployment dropping to a record low.
| Phillips-curve reading | More inflation pressure |
| Typical market move | Yields up, rate-cut bets down |
Traders use Phillips-curve thinking to link labour data with rate expectations. See Nonfarm Payrolls.
Short run vs long run
| Aspect | Short run | Long run |
|---|---|---|
| Relationship | Inverse trade-off | Little or none |
| Why | Sticky wages and prices | Expectations adjust |
| Policy implication | Some room to trade off | Inflation only, no jobs gain |
| See also | Misery index | Misery Index |
How the Phillips curve is used
Central bank forecasts
Linking jobs and inflation. See Federal Open Market Committee.
Reading jobs data
Tight labour = inflation risk. See Nonfarm Payrolls.
Rate expectations
Bond and FX market reactions. See Interest Rate.
Policy debates
How hard to push for full employment.
Advantages and disadvantages
Advantages
- Simple framework for jobs and prices.
- Explains central bank reactions.
- Useful for reading data releases.
Disadvantages
- Relationship has weakened over time.
- Broke down during stagflation.
- Depends on expectations.
Going deeper
Read as far as you need. Each level builds on the one before it.
Origins
Beginner
Economist A.W. Phillips published the original study in 1958, linking UK unemployment and wage growth from 1861 to 1957.1
Why it broke
Intermediate
In the 1970s the US saw stagflation — a high inflation rate, slowing growth and steadily high unemployment at the same time.2 Supply shocks and rising inflation expectations are commonly blamed.
Expectations-augmented
Advanced
Modern versions add inflation expectations: unemployment below its natural rate raises inflation relative to what people expect. See Inflation.
Common mistakes
Treating it as a law
It is a loose tendency.
Ignoring supply shocks
Oil shocks can break the pattern.
Forgetting expectations
They shift the curve.
Over-trading one jobs report
Trends matter more.
Check your understanding
Test yourself before moving on. Each answer comes with an explanation.
Key points to remember
- The Phillips curve links unemployment and inflation inversely.
- It works mainly in the short run.
- It broke down during 1970s stagflation.
- Expectations shift the relationship.
- Markets use it to read jobs data.
Frequently asked questions
Is the Phillips curve still valid?
What is the natural rate of unemployment?
Why do markets care?
Further learning
- Stagflation
When the curve fails.
- Misery Index
Inflation plus unemployment.
- Nonfarm Payrolls
The key jobs report.
- Federal Reserve
Who balances the trade-off.
Sources
This article is written in our own words. The sources below support the specific facts, rules and figures marked with a number in the text. Links open the original publisher’s page.
- Corporate Finance Institute. Phillips Curve (opens in a new tab) Checked .
- Corporate Finance Institute. Stagflation (opens in a new tab) Checked .
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