The Emergence of the Phillips Curve

Economists have long been interested in how the two variables—unemployment and inflation —might be connected.

In the 1950s, the economist A. W. Phillips analyzed nearly a century of data from the United Kingdom.

He studied the relationship between unemployment and changes in nominal wages.

He argued that when jobs are plentiful and workers are scarce, firms compete to hire workers by offering higher wages, which pushes nominal wages up quickly. This pattern is typically observed when unemployment is low.

But when unemployment is high, firms no longer have to compete as hard for workers, so nominal wage growth slows.

At that time, the focus was mainly on wages.

Economists later recognized that Phillips’s findings could also apply to inflation.

Many later studies that focused on unemployment and inflation found a negative relationship between the two variables.

One explanation is that rising wages increase firms’ production costs, and firms often respond by raising the prices they charge consumers, contributing to inflation. To summarize, the negative relationship between the inflation rate and the unemployment rate became known as the Phillips Curve.