The Philips Curve

In a 1958 paper, New Zealand born economist, A.W. Phillips published the results of his research on the historical relationship between the unemployment rate (u%) and the rate of inflation (π%) in Great Britain. His research indicated a stable inverse relationship between the u% and the π%. As u%↓, π%↑ ; and as u%↑, π%↓. The implication of this relationship was that policy makers could exploit the trade-off and reduce u% at the cost of increased π%. The Phillips curve was used as a rationale for the Keynesian aggregate demand policies of the mid-20th century.

Long Run Phillips Curve

 Because the Long-Run Phillips Curve exists at the natural rate of unemployment (un), structural changes in the economy that affect un will also cause the LRPC to shift.

Increases in un will shift LRPC à

Decreases in un will shift LRPC ß

Short Run Phillips Curve

Today many economists reject the concept of a stable Phillips curve, but accept that there may be a short-term trade-off between u% & π% given stable inflation expectations. Most believe that in the long-run u% & π% are independent at the natural rate of unemployment. Modern analysis shows that the SRPC may shift left or right.

Relating Phillips Curve to AS/AD

Summary

Changes in the AS/AD model can also be seen in the Phillips Curves

An easy way to understand how changes in the AS/AD model affect the Phillips Curve is to think of the two sets of graphs as mirror images.

NOTE: The 2 models are not equivalent. The AS/AD model is static, but the Phillips Curve includes change over time. Whereas AS/AD shows one time changes in the price-level as inflation or deflation, The Phillips curve illustrates continuous change in the price-level as either increased inflation or disinflation.