Phillips curve

In 1958, New Zealand economist A.W. Phillips published a paper showing that between 1861 and 1957, UK unemployment and wage inflation had a remarkably stable inverse relationship. Low unemployment → high wage inflation; high unemployment → low wage inflation. This was quickly extended to price inflation: low unemployment creates tight labour markets → higher wages → higher costs → higher prices. The empirical curve became a central tool of Keynesian demand management: governments believed they could "choose" a point on the Phillips curve, trading off some inflation for lower unemployment.

This confidence was shattered by the 1970s stagflation — simultaneous high unemployment and high inflation, which is inconsistent with a stable Phillips curve. Milton Friedman and Edmund Phelps, independently, had predicted this in 1968: the long-run Phillips curve is vertical. Workers eventually demand higher wages to compensate for expected inflation, so the trade-off only exists in the short run. In the long run, unemployment returns to its natural rate (the NAIRU) regardless of the inflation rate.

From the 1990s onward, the Phillips curve appeared to become extremely flat in advanced economies — meaning unemployment could fall to very low levels with little or no increase in inflation. During the 2010s, the US unemployment rate fell to 3.5% with inflation remaining near 2%. Many economists declared the Phillips curve "dead." The explanation: inflation expectations became well-anchored at 2%, so even tight labour markets did not trigger the wage-price dynamics of the 1970s. When workers expect 2% inflation, they ask for ~2% wage growth, which is consistent with 2% inflation — and the cycle doesn't spiral.

The 2021–23 episode partly rehabilitated the curve: when the labour market tightened to 3.4% unemployment while supply-side disruptions hit simultaneously, inflation surged. The sacrifice ratio analysis of the 2021–26 disinflation will help economists estimate whether the curve has steepened again or remained flat.

Modern central banks use Phillips curve logic implicitly, even if they don't always describe it that way. When the Fed says "the labour market is still too tight for us to be confident inflation will reach 2%," it is applying Phillips curve reasoning: excess demand for labour → wage growth above productivity → services inflation persistence. The NAIRU is the Phillips curve's key parameter — the unemployment rate at which inflation is stable. Estimates for the US NAIRU range from 3.8% to 4.5%, implying the 4.1–4.2% unemployment of early 2027 is near neutral. See our Federal Reserve research note on Phillips curve slope estimates.