Why is the short-run Phillips curve downward sloping?
Short answer: in the short run, low unemployment and high inflation tend to arrive together. When jobs are plentiful, firms bid up wages and prices; when jobs are scarce, that pressure eases. So less unemployment comes with more inflation — and plotting the two gives a line that slopes down.
The mechanism, step by step
Start from a burst of spending in the economy — say the central bank cuts interest rates and demand picks up.
- Stronger demand means firms sell more, so they hire more. Unemployment falls.
- With fewer unemployed workers left, firms have to raise wages to fill jobs. Labour gets more expensive.
- Higher wages raise costs, and strong demand lets firms pass those costs into higher prices. Inflation rises.
- So lower unemployment showed up alongside higher inflation. Run it in reverse — a slump — and you get high unemployment with low inflation.
The hidden condition: expectations stay put
The trade-off only works while people have not caught on. The short-run curve assumes expected inflation is fixed (the inflation rate workers and firms have built into their wage deals and price plans). When a demand surge pushes actual inflation above what people expected, wages set in advance lag behind, so labour is temporarily cheap in real terms and firms hire eagerly. That is the engine of the short-run trade-off — and it runs only as long as expectations trail reality.
Worked example
An economy sits at 6 percent unemployment and 2 percent inflation. The central bank stimulates demand. Over the next year firms scramble to hire, wages climb, and prices follow.
Before: unemployment 6 percent, inflation 2 percent
After: unemployment 4 percent, inflation 4 percent
Plot the points $(6\%, 2\%)$ and $(4\%, 4\%)$. Moving left (less unemployment) takes you up (more inflation). The line slopes down.
Why it is only short run
Once people live with 4 percent inflation for a while, they expect it. Workers demand raises that keep up with it, so labour is no longer cheap in real terms, and the extra hiring unwinds. Unemployment drifts back to its natural rate, but inflation stays high. The trade-off has evaporated — which is exactly why the long-run Phillips curve stands vertical at the natural rate.
Common misconception
“We can just accept a bit more inflation to keep unemployment low forever.” No. The trade-off is temporary. Once expectations catch up, the short-run curve shifts up: you end up back at the natural rate of unemployment, now stuck with permanently higher inflation and nothing to show for it.
Frequently asked questions
- Why does the short-run Phillips curve slope downward?
- Because low unemployment and high inflation tend to show up together. When almost everyone who wants a job has one, firms must offer higher wages to attract staff, and strong spending lets them raise prices. When unemployment is high, that pressure fades and inflation cools. Inflation and unemployment move in opposite directions, which draws a downward-sloping line.
- What is the difference between the short-run and long-run Phillips curve?
- The short-run curve slopes down because it holds inflation expectations fixed — people have not yet adjusted to the new inflation rate. The long-run curve is vertical at the natural rate of unemployment, because once expectations catch up, the trade-off disappears and only the inflation rate is left changed.
- Why does low unemployment cause inflation?
- With few unemployed workers left to hire, firms compete for staff by raising wages, which pushes up their costs. At the same time, the strong demand that produced all those jobs lets firms pass higher costs into higher prices. Both forces lift the inflation rate.
- What shifts the short-run Phillips curve?
- A change in expected inflation shifts the whole curve. If people come to expect higher inflation, they build it into wage demands and contracts, so every unemployment rate now comes paired with more inflation — the curve shifts up. A supply shock, like a sudden spike in oil prices, shifts it too.
- Can policymakers exploit the trade-off forever?
- No. A central bank can push unemployment below the natural rate for a while by letting inflation run, but the gain is temporary. Once workers and firms expect the higher inflation, they demand higher wages, unemployment drifts back to the natural rate, and only the higher inflation remains.
- Who discovered the Phillips curve?
- A.W. Phillips documented the link between wage inflation and unemployment in British data in 1958. Milton Friedman and Edmund Phelps later added the role of expectations, which is what separates the downward-sloping short-run curve from the vertical long-run one.
Put the trade-off to work
Practice the monetary-policy chain on Econ Academy, or measure inflation from a price index with the calculator.