What is the Phillips Curve?

The Phillips Curve is an economic idea linking unemployment and inflation: when unemployment is low, wages and prices often come under upward pressure; when unemployment is high, that pressure often weakens. The relationship is not a permanent trade-off. It depends on what workers, firms and financial markets expect inflation to do. If those expectations change, the curve can shift, which is why modern economics connects the Phillips Curve with the non-accelerating inflation rate of unemployment, or NAIRU: the jobless rate at which inflation tends to stay stable rather than speed up or slow down.

What Phillips noticed

A. W. Phillips compared unemployment with wage growth and found a clear pattern. Tight labour markets, where fewer people were looking for work, tended to go with faster wage growth. Weaker labour markets, where more people were looking for work, tended to go with slower wage growth.

The logic is simple. When employers compete harder for workers, they may raise pay to hire or keep staff. If wage costs rise faster than productivity, firms may increase prices to protect margins. That can turn wage pressure into broader inflation pressure.

This made the Phillips Curve look like a policy menu. Lower unemployment seemed to come with higher inflation, while lower inflation seemed to require higher unemployment. The curve gave economists and policymakers a tidy way to describe a difficult trade-off.

Why the curve is not fixed

The simple version fails when people change their expectations. Inflation is not shaped only by today’s unemployment rate. It is also shaped by what people think prices will do next.

If workers expect higher inflation, they may ask for higher pay before prices rise further. If firms expect higher costs, they may raise prices earlier. Those decisions can make higher inflation arrive even at the same unemployment rate. In that case, the Phillips Curve has shifted rather than merely moved along.

The reverse can also happen. If people believe inflation will stay under control, wage and price setting may stay calmer. The same level of unemployment can then be consistent with lower inflation.

This is why the Phillips Curve works better as a short-run relationship than as a long-run rule. Surprise changes in demand can temporarily move unemployment and inflation in opposite directions. But once expectations adjust, the old trade-off weakens.

How NAIRU fits in

NAIRU means the non-accelerating inflation rate of unemployment. It is the unemployment rate consistent with stable inflation, not a precise point that can be seen directly.

If unemployment is below the NAIRU, inflation tends to accelerate because the labour market is putting sustained pressure on wages and prices. If unemployment is above it, inflation tends to slow because demand for labour is weaker. At the NAIRU, inflation is steady, although it may be steady at a high or low level.

NAIRU can change as an economy changes. Skills, labour market rules, productivity, demographics and the ease of matching workers with jobs can all affect it. That makes it useful, but also uncertain. Economists estimate it; they do not observe it in the way they observe an unemployment rate.

What the Phillips Curve teaches

The Phillips Curve is best read as a warning against simple choices. Low unemployment can create inflation pressure, but the strength of that pressure depends on expectations and on how the labour market works.

The lasting lesson is that credibility matters. When people trust that inflation will remain stable, the relationship between unemployment and inflation is easier to manage. When expectations move, the same unemployment rate can produce a different inflation outcome.