The Phillips Curve

In 1958 a New Zealand economist named A. W. Phillips dug through almost a century of British data, from 1861 to 1957. He was looking for a link between two numbers: how fast wages rose, and how many people were out of work. He found one. When unemployment was low, wages shot up. When unemployment was high, wages barely moved. Plot those two numbers against each other and the dots trace a downward-sloping line.

Wages drive prices, so the same pattern shows up for inflation. Inflation is the rate at which prices rise across the economy. Unemployment is the share of people who want a job but cannot find one. Phillips’s finding, restated in those terms, is a trade-off: lower unemployment comes paired with higher inflation, and lower inflation comes paired with higher unemployment. You seem to be able to buy less of one only by accepting more of the other.

Why would low unemployment push prices up? When almost everyone who wants work already has it, firms must fight over the few workers left. To hire or keep staff, they raise wages. Higher wages raise firms’ costs, and firms pass those costs on as higher prices. So a hot, low-unemployment economy runs hotter prices. Run the logic backward for a slack, high-unemployment economy: plenty of spare workers, little pressure to raise wages, so prices stay calm.

Read against the curve, a policymaker’s options look like a menu. Tighten policy — raise interest rates, cut spending — and you slide down the curve: unemployment climbs but inflation eases. Stimulate — cut rates, spend more — and you slide up the curve: unemployment falls but inflation rises. In the 1960s many economists and governments read it exactly this way. The curve looked like a dial they could set wherever they pleased.