Phillips Curve
The historical inverse relationship between unemployment and inflation: lower unemployment tends to produce higher inflation.
What is Phillips Curve?
The Phillips Curve describes the observed inverse relationship between unemployment and inflation: when unemployment is low, workers have more bargaining power, wages rise, and businesses pass costs on as higher prices — increasing inflation. When unemployment is high, competition for jobs suppresses wages and prices. First identified by economist A.W. Phillips in 1958 using UK data, the relationship became a cornerstone of macroeconomic policy: policymakers could seemingly 'trade off' higher inflation for lower unemployment. The relationship broke down in the 1970s stagflation (high inflation and high unemployment simultaneously), leading economists to distinguish between short-run and long-run Phillips Curves. The long-run curve is thought to be vertical at the natural rate of unemployment.
Example
In the late 1960s, US policymakers deliberately ran the economy 'hot' — tolerating unemployment below 4% — believing the Phillips Curve trade-off allowed this without unacceptable inflation. Instead, inflationary expectations became embedded and inflation accelerated into the 1970s, demonstrating the limits of the naive Phillips Curve model.
Source: Federal Reserve Bank of San Francisco — Natural Rate of Unemployment and the Phillips Curve