What is the Phillips Curve?
The Phillips curve shows the inverse relationship between unemployment and inflation named after British economist AW Phillips.
Once inflation and unemployment rates were plotted on a scatter diagram, the data appeared to demonstrate an inverse and stable relationship between inflation and unemployment.
The curve suggested that changes in the level of unemployment have a direct and predictable effect on the level of price inflation. The accepted explanation during the 1960’s was that a fiscal stimulus, and increase in AD, would trigger the following sequence of responses:
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An increase in the demand for labour as government spending generates growth.
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The pool of unemployed will fall.
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Firms must compete for fewer workers by raising nominal wages.
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Workers have greater bargaining power to seek out increases in nominal wages.
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Wage costs will rise.
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Faced with rising wage costs, firms pass on these cost increases in higher prices.
