The Phillips Curve is an economic theory published by William Phillips in 1958 that states inflation and unemployment have an inverse relationship. In other words, a rise in inflation is associated with a fall in unemployment because it assumes economic growth is occurring. Even more simply, higher inflation predicts higher employment and wages. This discovery was made after analyzing data on U.K. wages and unemployment rates between 1861–1957.³ Several economic theorists supported the idea of a the stable trade-off between inflation and unemployment and believed it was impossible to have both increasing simultaneously. Until…
Stagflation Debunked Theory
The concept of the Phillips Curve was somewhat disproven in the U.S. during the 1970s oil crisis when there happened to be high levels of both inflation and unemployment.¹ Instead of rising inflation being correlated to economic growth, the economy slowed and faced high unemployment. To understand the severity of the situation, it is worth highlighting the time period between 1973 and 1975, where the U.S. GDP declined for six consecutive quarters and tripled its inflation.³ Along with an expected rise in unemployment, this was the first time in the U.S. that all three factors occurred simultaneously. This economic cycle is characterized as stagflation and can be summarized as:
- Slow economic growth
- High unemployment rate — 4–5% is healthy
- Rising prices/high inflation — 2% is healthy
During the period of stagflation in the 1970s, the negative effects were often measured with a misery index, which sums the inflation rate and unemployment rate to measure distress felt by citizens.² Given the figures above, a summation of 6–7% would be considered a satisfactory misery index. In contrast, the greater the index, the greater the “misery” in regard to ones economic well-being.
As a bit of history, the misery index was used by Jimmy Carter during the 1976 U.S. presidential campaign to criticize his opponent, which was over 12.5% at the time. Four years later, candidate Ronald Reagan resurfaced the index by pointing out that “the misery index had increased under Carter.”² However, the simplicity of the index can be a signal that it is flawed because it leaves out key factors, and it treats both equally. According to Investopedia, “a 1% increase in unemployment likely causes more misery than a 1% increase in inflation.”²
Flattened Curve
Based on the graph above, we can see the inverse relationship between inflation and unemployment from 1975–1984 that the Phillips Curve theorized. However, post the oil crisis, we can see how much the curve flattened. In other words, inflation has become less responsive to unemployment. Why did this occur? While there is not a definitive answer, there are several interpretations for the weakened relationship:
- Monetary Policy — The Fed adopted more aggressive anti-inflation (aka tight) policies after the 1970s. These commitments aim to maintain low and stable inflation, reducing the sensitivity of inflation to unemployment due to effective “anchoring” of expectations.
- Globalization — Has put downward pressure on prices because production can be increased much easier than before.
- Technology Advancement — Increased productivity has put downward pressure on prices.
References
[1]: Investopedia: The Phillips Curve Economic Theory Explained (2024)
[2]: Investopedia: Misery Index: Definition, Components, History, and Limitations (2023)
[3]: Federal Reserve Bank of St. Louis: What Is the Phillips Curve (and Why Has It Flattened)? (2020)
[4]: The Economist: The Phillips curve may be broken for good (2017)
[5]: YouTube: Flattening of the Ph illip’s Curve
