Phillips Curve

There is a general inverse relationship between unemployment and inflation, which means that as inflation goes up, unemployment typically goes down and vice versa. So as an economy begins to output more because of an increase in demand, more workers are hired to produce at the higher levels of output while also increasing inflation. This means that shifts in the demand curve correspond to movement along The Phillips Curve. On the other hand, if an economy outputs less because of a shift left in supply, workers are laid off while inflation increases. This stagnant economy with high inflation corresponds to an actual shift in The Phillips Curve and is often called "stagflation".

And through another lens, The Phillips Curve is not the, uh...“fill up” curve, which tracks the relationship between cholesterol levels and eating high volumes of cheap fried chicken.

The Phillips Curve. It's an economic model that describes an inverse relationship between unemployment levels and the amount of inflation in an economy.

Inverse relationship. Means they move in opposite direction. Like...as the amount you talk about economics goes up, the number of dates you get goes down.

Okay, let's apply that principle to the Phillips curve.

You have the unemployment rate. A figure that tracks the percentage of the population who are looking for work but can't find a job. A high unemployment rate means a lot of people are out of jobs. A sign that the economy is weak. Bread lines. Hoovervilles. Thirty-year-olds moving back in with their parents. All kinds of disasters.

Meanwhile, a low unemployment rate means that nearly everyone who wants a job, has one. A good sign for the economy. Then you have inflation. A measure that shows the rate at which prices are rising across the economy.

High inflation: prices rising quickly. Things get more expensive. It's tough on consumers. Each time prices go up, people can afford fewer pork rinds or superhero bobbleheads or whatever they’re looking to buy.

On the other side, there’s low inflation. Prices are rising slowly. A little at a time. Relatively stable currency. Easy for people, and businesses can make long-term spending plans. So under The Phillips Curve theory, unemployment and inflation have an inverse relationship. When unemployment is high, inflation will be low. Meanwhile, when inflation is high, unemployment will be low.

The Phillips Curve is named after an economist named William Phillips, who first published his theory in the 1950s. Fun facts about William Phillips: He was born in New Zealand, and his real first name was Alban. Okay, moving on. The mechanics behind the Phillips Curve work like this:

There's a high level of aggregate demand in an economy, meaning that people have cash and are looking to buy stuff. All the pork rinds and superhero bobbleheads and whatever. To get everybody all the stuff they want to buy, companies have to hire more people to, uh, make the stuff. Unemployment rates fall as more people get hired.

Meanwhile, the additional demand drives prices higher. Rising prices. That's more or less the definition of inflation. Inflation high, unemployment low. Phillips Curve in action.

Now the other side. Aggregate demand is low. People don't have money to buy stuff. People have to ration their intake of pork rinds and cut back on their purchase of superhero bobbleheads. Companies don't need as many workers. They don't hire, or they even lay people off.

Unemployment is high. Meanwhile, without much demand, there's no upward pressure on prices. Inflation is low. Phillips Curve in action again.

The Phillips Curve informs a lot of economic decision-making. It gets a lot of use in the real world.

Let’s just take the United States as an example. In the U.S., the main organization in charge of keeping the economy humming is the Federal Reserve. It sets what's called monetary policy, basically deciding how much money there is and how fast it's allowed to move through the economy.

The Fed has two stated goals: keep inflation under control, and keep unemployment as low as possible.

You'll notice the Phillips Curve problem here. The Fed's trying to have it both ways. Inflation low. Unemployment low. Under the Phillips Curve theory, you can't really have both at once. So in practice, the Fed is constantly adjusting to stay in the sweet spot. Like trying to keep the perfect water temperature in the shower.

When the economy is sluggish and unemployment is high, the Fed will launch some more inflationary policies. Like turning up the hot water. They lower interest rates and put more money into the system. It’s easier to borrow money and easier for companies to invest.

Unemployment goes down, but inflation starts to rise. Once inflation gets a little too strong, the Fed will crank up some cold water. Higher interest rates. Borrowing and investing get more expensive. Less money moving around. Inflation comes under control, but there’s a risk that unemployment will start to rise.

So the Fed is constantly going back and forth to keep a reasonable balance on the Phillips Curve tradeoff. This management is complicated by the fact that Fed policies take a little time to work their way through the system. The Fed doesn’t just wave a wand or push a button and Bam! Economy fixed. It takes a little time.

Fed activities don’t immediately lead to economic results. They make a move; then they have to wait to see how things work out. There's a problem though. It's not clear that The Phillips Curve works in the long term.

There's a fair amount of evidence that it works under most conditions in the short term. But in the long term, many economists feel the Phillips curve starts to fall apart.

In this anti-Phillips conception, the rate of inflation is decided by monetary issues, i.e., the amount of cash floating around in an economy. Unemployment doesn’t really play a role. Meanwhile, long-term employment is the result of economy-wide levels of supply and demand for labor.

It means you can't just inflate your way out of every high-unemployment situation. A bummer if you happen to run the Fed. It means situations can come up for which there’s no clear Phillips playbook. The U.S. learned this lesson the hard way in the 1970s. The time of leisure suits and getting into drunken fights with Keith Richards at Studio 54. And the time of something known as stagflation.

During this time, the U.S. economy experienced stagnant growth, complete with relatively high unemployment. Meanwhile, at the same time, the country saw high inflation rates. High unemployment. High inflation. A real Phillips Curve conundrum. Eventually, the Fed solved the problem by jacking up interest rates. The move got rid of the inflation, but it also contributed to a recession.

Once inflation slowed, the economy was able to resume growth, and we got the boom years of the 1980s. Aerobics outfits and boom boxes. And Keith Richards probably still getting in drunken fights, except maybe now they happen at the mall...