Phillips Curve

The Phillips curve is a diagram representing the relationship between unemployment and inflation.

The graph shows an inverse relationship between unemployment and inflation.

Essentials of the Phillips Curve

Inflation rate (%) on the Y-axis

Unemployment rate (%) on the X-axis

Two types of Phillips Curve

-Short run (SRPC)

-Long run (LRPC)

Long-Run Phillips Curve

The Phillips curve theory was supported by data up to the 1970's, where stagflation lead to high unemployment and high inflation at the same time.

The LRPC represents the idea that there is no trade-off between inflation and unemployment.

LRPC = Natural rate of unemployment (NRU) or full employment

MILTON FRIEDMAN

According to new classical econiomicsts, the conomy will tend towards its long-run equilibrium at the full level of output.

Same goes for the long run Phillips curve (there is no trade-off in the long run).

"Do not use expansionary demand-side policies to bring unemployment under NUR, it will only create inflation."

LRPC is unemployment at the natural rate of unemployment, NRU.

NRU consists of frictional, seasonal and structural unemployment.

Natural rate of unemployment will occur when the economy is at full employment and the labor makret is in equilibrium.

Supply side policies will reduce the natural rate and shift LRPC to the left.

NRU per country depends on:

Availability of unemployment benefits

Trade union power

Extent of labor market regulations

Wage-setting practices by firms