An economic concept developed by A. W. Phillips stating that inflation and unemployment have a stable and inverse relationship. According to the Phillips curve, the lower an economy’s rate of unemployment, the more rapidly wages paid to labour increase in that economy.
Phillips conjectured that the lower the unemployment rate, the tighter the labour market and, therefore, the faster firms must raise wages to attract scarce labour. At higher rates of unemployment, the pressure abated. Phillips’s “curve” represented the average relationship between unemployment and wage behaviour over the business cycle. It showed the rate of wage inflation that would result if a particular level of unemployment persisted for some time.
Phillips found that there was a trade-off between unemployment and inflation, so that any attempt by governments to reduce unemployment was likely to lead to increased inflation. This relationship was seen by Keynesians as a justification of their policies.
The curve sloped down from left to right and seemed to offer policymakers a simple choice – you have to accept inflation or unemployment. You can’t lower both.
The movement along the curve, with wages expanding more rapidly than the norm for a given level of employment during periods of economic expansion and slower than the norm during economic slowdowns, led to the idea that government policy could be used to influence employment rates and the rate of inflation. By implementing the right policies, governments hoped to achieve a permanent balance between employment and inflation that would result in long-term prosperity.
In order to achieve and maintain such a scenario, governments stimulate the economy to reduce unemployment. This action leads to higher inflation. When inflation reaches unacceptable levels, the government tightens fiscal policies, which decreases inflation and increases unemployment. Ideally, the perfect policy would result in an optimal balance of low rates of inflation and high rates of employment.