Phillips Curve: An inflation-unemployment trade-off?

The belief in an inflation-unemployment trade-off is ingrained in macroeconomics, financial markets, and media. The trade-off is often expressed in various ways:

  • Markets fear that if the unemployment rate gets too low, then inflation will rise.
  • Macroeconomics has asserted that allowing inflation to rise can lower the unemployment rate—at least temporarily. The “Phillips Curve” measured the relationship and introduced the idea of a “natural rate of unemployment”—below which inflation risks rise.

Clear evidence of the trade-off, however, is hard to find in the data—with the possible exception of the 1950s when the Phillips curve was first measured. See chart.

Instead, the experience evident in the data more often has run counter to the expected trade-off. The 1970s produced periods of high unemployment and high consumer price inflation—stagflation—that prompted changes to the theory. And since the mid-1990s, periods of extremely low unemployment have occurred amid persisting low consumer inflation.

But is this experience also a matter of measuring the wrong thing?

Consumer price inflation generally has been shadowed by wage inflation. Before the pandemic, however, wage inflation was trending higher amid the very low unemployment rate. It could be that measures more closely tied to the labor market—particularly labor-intensive service sectors—is where the inflation-unemployment trade-off is more likely to be found.

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