Why is the long-run Phillips curve vertical?
Short answer: the trade-off between inflation and unemployment only works when inflation catches people by surprise. Once workers and firms expect that inflation, they build it into wages and prices, and unemployment slides back to its natural rate. Because every inflation rate ends up paired with the same natural rate of unemployment, the long-run Phillips curve is a vertical line.
The mechanism in five steps
- Start at the natural rate of unemployment, with actual inflation equal to what people expected. Workers' nominal wages already account for the inflation they foresee.
- The central bank boosts aggregate demand, and inflation rises above what people expected. Prices climb faster than the wages that were locked in earlier.
- With wages fixed but prices higher, real wages fall. Hiring a worker is suddenly cheaper, so firms expand and unemployment drops below the natural rate. This is a movement along the short-run Phillips curve.
- Workers notice that prices rose and negotiate higher nominal wages to restore their real pay. Real wages climb back, firms cut hiring, and unemployment returns to the natural rate.
- But now everyone expects the higher inflation, so the short-run Phillips curve shifts up. The economy sits back at the natural rate of unemployment, just with higher inflation. Connect those natural-rate points across different inflation rates and you trace a vertical line — the long-run Phillips curve.
Worked example
Suppose the natural rate of unemployment is 5 percent and inflation has been steady at 2 percent.
Short run: the central bank stimulates demand; inflation jumps to 6 percent. Caught by surprise, firms hire, and unemployment falls to 3 percent.
Adjustment: workers renegotiate wages for 6 percent inflation. Real wages recover, hiring slows.
Long run: unemployment returns to 5 percent — the natural rate — while inflation stays at 6 percent.
Net result: the same unemployment as before, but permanently higher inflation. The economy moved up the vertical long-run Phillips curve, not down a stable trade-off.
This is precisely the 1970s lesson: stimulus bought lower unemployment only briefly, then left the United States with high inflation and high unemployment at the same time — stagflation.
Common misconception
“A government can permanently trade higher inflation for lower unemployment.” No — the trade-off exists only while inflation is unexpected. Once expectations adjust, unemployment snaps back to the natural rate and the only lasting effect is higher inflation. Friedman and Phelps warned of this before the 1970s proved it.
Frequently asked questions
- What is the natural rate of unemployment?
- The natural rate of unemployment is the rate that remains when the economy is at full employment — the sum of frictional unemployment (people between jobs) and structural unemployment (skills or location mismatches). Cyclical unemployment is zero at the natural rate. It is the unemployment rate the economy gravitates back to in the long run.
- What is the short-run Phillips curve?
- The short-run Phillips curve shows a downward-sloping trade-off: lower unemployment comes with higher inflation, and vice versa. It holds only while inflation differs from what people expected. Each short-run Phillips curve is drawn for one particular level of expected inflation.
- Why does the short-run Phillips curve shift?
- It shifts when expected inflation changes or when a supply shock hits. If people come to expect higher inflation, the whole short-run curve shifts upward, so any given unemployment rate now comes with higher inflation. A negative supply shock also shifts it up, worsening both inflation and unemployment at once.
- What broke the original Phillips curve in the 1970s?
- Stagflation. The 1970s combined high inflation with high unemployment — a combination impossible on a single stable downward-sloping Phillips curve. Milton Friedman and Edmund Phelps had predicted exactly this: once workers expected the inflation, the trade-off vanished, and the economy returned to the natural rate at a higher inflation rate.
- What is NAIRU?
- NAIRU stands for the non-accelerating inflation rate of unemployment — the unemployment rate at which inflation is stable rather than rising or falling. It is essentially the modern name for the natural rate. Pushing unemployment below NAIRU causes inflation to accelerate; the long-run Phillips curve is vertical at this rate.
- Can policy push unemployment below the natural rate permanently?
- No. Stimulus can lower unemployment below the natural rate only while inflation is higher than expected. Once expectations catch up, wages rise, firms cut back, and unemployment returns to the natural rate — now with permanently higher inflation. The gain in employment is temporary; the higher inflation can last.
See the short-run and long-run Phillips curves on a live graph
Econ Academy's macroeconomics course shows how the short-run curve shifts as expectations change — with interactive graphs and spaced repetition so the logic sticks.