Phillips Curve Inflation vs Unemployment

Phillips Curve: inflation × unemployment trade-off

The Phillips curve says inflation and unemployment move in opposite directions. The New Zealand economist William Phillips put it forward in 1958, having combed through UK wage and unemployment data spanning 1861–1957. The expectations-augmented version is written as π = π̂ − β(u − u*). Here π̂ stands for expected inflation, u for the actual unemployment rate, and u* for the natural rate, also called the NAIRU.

In 1968 Milton Friedman and Edmund Phelps argued that this trade-off is a short-run affair. Over the long haul the curve stands vertical at the NAIRU, since workers and firms eventually revise what they expect inflation to be. Then came the stagflation of the 1970s, where high inflation and high unemployment showed up together. That episode sank the simple version and lent weight to the expectations-augmented model.

Applications

Central banks such as the Banco Central do Brasil (BCB), the Fed and the ECB lean on Phillips curve estimates when they set interest rates under inflation targeting. The same curve shows up in DSGE models, in output-gap forecasts, and behind the call on whether an economy is running too hot.

FAQ

Does the Phillips curve still work? The simple version no longer does. The expectations-augmented one, though, remains a staple of monetary policy, even if the slope β looks to have flattened across advanced economies since the 2000s.

What is the NAIRU? It stands for Non-Accelerating Inflation Rate of Unemployment, the unemployment rate that keeps inflation stable. Estimates for Brazil put it somewhere between 7% and 9%.

Can a country have low unemployment without inflation? It can. That happens when productivity rises, when expectations stay anchored, or when the NAIRU itself drops thanks to better matching and less rigidity in the labour market.