The Artwork of the Phillips Curve

any standard Macroeconomic textbook of the final 50 years and you’ll rapidly land on a web page that mentions the Phillips curve. After which one other web page, after which one other…

For instance, the Macroeconomics textbook, creatively titled “Macroeconomics” by C. Jones and a part of Cambridge college’s BA Economics curriculum, references the “Phillips curve” a staggering 143 occasions throughout 67 pages, protecting over 10% of the 641-page brick. It takes up extra space than virtually¹ all different macroeconomic fashions, together with the “MP curve” (24 pages), the “Cobb-Douglas” manufacturing perform (17 pages), the “Romer mannequin” (42 pages), the “AS/AD framework” (51 pages), and the “DSGE fashions” (42 pages).

In brief, the Phillips curve is a reasonably large deal in fashionable macroeconomics.

As for the contents of these 67 pages, the overwhelming majority is available in explaining the Phillips curve’s mathematical logic, and scientific equations. As an illustration, right here’s a small pattern from the ebook talked about above:

“…In regular occasions, you’d anticipate costs within the economic system to proceed to rise at a fee of 5 %, and also you’d increase your costs by this identical quantity. Nonetheless, given the weak spot in your business, you’ll in all probability increase costs by lower than 5 %, in an effort to extend the demand on your items.This reasoning motivates the price-setting habits that underlies the Phillips curve. Recall that πt ≡ (Pt+1− Pt) / Pt ; that’s, the inflation fee is the share change within the total value stage over the approaching 12 months. Corporations set the quantity by which they increase their costs on the premise of their expectations of the economywide inflation fee and the state of demand for his or her merchandise:

Right here, πet denotes anticipated inflation — the inflation fee that companies suppose will pre-vail in the remainder of the economic system over the approaching 12 months…”

p. 318–9, “Macroeconomics”, fourth version. Charles Jones.

It isn’t solely used at universities. Central banks all through the globe depend on the Phillips curve findings to clarify the economic system and modify their rates of interest. For instance, in February 2025, when the Financial institution of England (BoE) lowered their rate of interest to 4.5%, their clarification explicitly cited Phillips curve reasoning:

“Ought to there be higher or longer-lasting weak spot in demand relative to produce, this might push down on inflationary pressures, warranting a much less restrictive path of Financial institution Fee [BoE interest rate]. If there have been to be extra constrained provide relative to demand, this might maintain home value and wage pressures, in step with a comparatively tighter financial coverage path.”Financial institution of England’s “Financial Coverage Abstract, February 2025”

That may have a bit an excessive amount of economist jargon for the lay individual. How about this quote from the present Chair of the Federal Reserve, Jerome Powell:

[The] persistent shortfall in inflation from our goal has led some to query the standard relationship between inflation and the unemployment fee, also called the Phillips curve.… My view is that the information proceed to indicate a relationship between the general state of the labor market and the change in inflation over time. That connection has weakened over the previous couple of a long time, however it nonetheless persists, and I consider it continues to be significant for financial coverage.“The Outlook for the U.S. Financial system.” April 2018. Jerome Powell, Chair of the Federal Reserve (2018-present).

This text is not concerning the Phillips curve you can see in macroeconomic textbooks or central financial institution statements, however slightly the Phillips curve they deliberately pass over. The high quality print particulars glueing all that sensible physics-like reasoning collectively. The assumptions, the historical past, the revisions, and the inconvenient information. In brief, the macroeconomists provides you with the science of the Phillips curve, I intend to provide the artwork of the Phillips curve.

A Quick Historical past

The Phillips curve was, unsurprisingly, conceived by a chap referred to as Phillips — Alban William Housego Phillips to be exact. Whereas working on the London Faculty of Economics within the Nineteen Fifties, he studied the connection between unemployment and inflation in the UK from 1861 to 1913. What he discovered was an inverse correlation: as wage inflation elevated, unemployment decreased.

For the subsequent few years Phillips and different macroeconomic lecturers continued to seek for empirical proof supporting such an interesting correlation. And so they did! Phillips discovered that the connection endured when the dataset was prolonged to 1957. Samuelson and Solow, economists on the Massachusetts Institute of Know-how (MIT), revealed a paper in 1960 referred to as “Analytical features of anti-inflation coverage”. In it they discovered the identical relationship as Phillips had, however utilizing U.S. information from 1934 to 1958.

However Samuelson and Solow’s paper did way more than this. They expanded Phillips’ authentic work by demonstrating that the connection utilized not solely to unemployment and wage inflation, but in addition to unemployment and common value inflation, at the very least for the U.S. information they analysed² .

Moreover, they proposed a causal mannequin for this correlation, a theoretical framework that gained help from the rising recognition of Keynesian economists. It may’t be overstated simply how vital a leap this was from Phillips’ authentic work. Whereas Phillips had merely documented a statistical relationship — much like how ice cream gross sales and drowning deaths each rise in summer season months (because of the hidden variable of heat climate) — Samuelson and Solow have been primarily claiming that manipulating one variable may straight management the opposite. Utilizing our analogy, ice cream gross sales laws could possibly be used as a coverage instrument to cut back drownings, or conversely, that swimming security measures may impression the ice cream market.

Samuelson and Solow’s mannequin was so simple as:

$$pi = f(U)
f'(U)

The place:

• π represents the inflation fee
• U represents the unemployment fee
• f is a perform that describes an inverse relationship

This causal concept was a very highly effective discovery, not solely as a result of it was so easy, requiring solely two metrics, however as a result of these two metrics have been potential to measure, not like awkward inputs utilized in different fashions comparable to animal spirits, expectations, and marginal propensity to devour. For over a century, pesky Classical and Austrian college economists had argued that it was unimaginable to grasp the economic system from broad aggregations on the premise that there have been various kinds of underlying unemployment and inflation that every one look the identical for those who combination them. To actually perceive why inflation was this stage or unemployment was that stage, they argued, you’d should dig into the small print, and assess the scenario at a microeconomic and even particular person human stage. “Hogwash” stated the Keynesian macroeconomists, who weren’t solely beginning to construct a wholesome assortment of fashions constructed on aggregated metrics, however had policymakers paying attention to them.

As with different Keynesian fashions, Samuelson and Solow inspired policymakers to use the mannequin. Stating of their 1960 paper: governments may modify inflation and unemployment as if it have been a “menu of alternative”³.

For the subsequent decade, governments started to heat to the concept that they could possibly be the final word conductor of the economic system, turning dials and urgent knobs to be able to transfer their nation within the route they needed. All through the Nineteen Sixties, new information continued to again the Phillips curve, which lead policymakers to make bolder and bolder coverage selections primarily based on Samuelson and Solow’s mannequin.

For instance, in 1971–1972, with help from President Nixon, Federal Reserve Chairman Arthur Burns pursued an expansionary financial coverage. This concerned decreasing the federal funds fee from roughly 5.5% in early 1971 to round 3.5% by mid-1972, whereas rising the M1 cash provide at an accelerated annual fee from 5.4% in 1970 to eight.2% by 1972. These Phillips curve-influenced insurance policies aimed to cut back unemployment, which did fall from 5.9% in 1971 to five.1% by late 1972. Initially, inflation remained comparatively contained at 3.2% in 1972, helped by one other coverage Nixon had enacted of freezing wage and value controls for 90 days, creating the looks that the Phillips curve tradeoff was working. Regardless of these preliminary successes, when Nixon’s wage and value controls have been lifted, each inflation and unemployment rose concurrently. Inflation surged to 12.3% by 1974 whereas unemployment elevated to over 7%.

The U.S. economic system was exhibiting one thing macroeconomists had beforehand thought unimaginable: excessive inflation and excessive unemployment occurring concurrently — a phenomenon that got here to be often called “stagflation.”

This wasn’t only a blip for a few years both. Information factors for the entire decade of the Seventies not fell neatly alongside the Phillips curve however as an alternative a random scattering, as if there was no correlation in any respect (that’s being type, some may say there was a optimistic correlation between unemployment and inflation). The get together was over. The elegant trade-off that had empowered governments to fine-tune financial outcomes for a decade was breaking down earlier than policymakers’ and economists’ eyes.

The stagflation interval primarily validated what the Classical and Austrian critics had warned about — that aggregated metrics alone couldn’t seize advanced financial realities. 

Or had it? 

To not be so fast to offer in, the Phillips curve fans sought to search out excuses for the inconvenient information.

Robert Solow, who had co-authored the influential 1960 paper with Paul Samuelson, insisted that the elemental relationship remained legitimate regardless of the stagflation anomaly. He and different Keynesians prompt the curve had merely “shifted to the fitting giving a worse trade-off due to cost-push inflation” attributable to the exterior shock of the 1973 OPEC oil disaster — not as a result of the underlying concept was flawed. In different phrases, the Phillips curve wasn’t incorrect, however was merely lacking a small element in its equation, what would later be coined as “provide shocks”. In mathematical phrases, the equation modified to:

$$pi = f(U) + O
f'(U)

The place:

• π represents the inflation fee
• U represents the unemployment fee
• f is a perform that describes an inverse relationship
• Ο (the greek letter omicron, not zero) represents provide shocks

Nonetheless, sadly for Solow and others, there was vital proof towards the provision shock view that the Seventies stagflation was solely because of OPEC’s oil value quadrupling in October 1973. Information exhibits that stagflation started earlier, with unemployment rising from 3.6% to 4.9% between 1968 and 1970, whereas inflation rose from 4.7% to five.6% throughout the identical interval. In consequence, there was going to have to be extra tinkering for the Phillips curve to cheat demise.

And tinkering there was. 

Phillips curve fans began to search for one thing, something, that might save them and their mannequin — even when it meant stepping into mattress with a earlier enemy. 

Enter Milton Friedman and Edmund Phelps. In 1967–1968, they developed critiques of the Phillips curve. Their argument was:

1. The Phillips curve ignored expectations. Individuals aren’t mechanical elements in an financial machine. They adapt. They be taught. If the federal government constantly creates inflation to cut back unemployment, folks will finally catch on and modify their behaviour accordingly. 
2. The Phillips curve ignored the idea of the “pure fee” of unemployment. When unemployment falls under this pure fee, wages rise, employers increase costs, and inflation will increase. As soon as employees notice inflation is consuming their wage positive factors, they demand even greater wages, creating an inflationary spiral. Ultimately, unemployment returns to its pure fee, however with greater inflation.
3. Level 1 and a couple of mixed means there was no everlasting trade-off between unemployment and inflation, solely a brief one that may disappear as soon as folks up to date their expectations.

Initially, mainstream macroeconomists largely dismissed these critiques. In any case, the information nonetheless supported the Phillips curve, and governments have been having fun with their newfound energy to “fine-tune” the economic system. Why let pesky monetarists like Friedman rain on their parade? The Keynesian institution, firmly entrenched in academia and coverage circles, had little curiosity in a concept that undermined their affect.

However when the Seventies occurred, they reached for the closest life raft: the expectations-augmented Phillips curve that Friedman and Phelps had proposed years earlier. A minimum of their mannequin was nonetheless referred to as the “Phillips curve”.⁴

Out of the blue, the once-dismissed concept turned the accepted knowledge. The identical economists who had scoffed at Friedman and Phelps have been now explaining to policymakers that, after all, there was no long-run Phillips curve trade-off. In fact expectations matter.

This handy pivot allowed the macroeconomics career to avoid wasting face. Once more, slightly than admitting the elemental flaws of their aggregation-based strategy, they may declare that the mannequin was simply lacking a number of extra variables.

The brand new Phillips curve equation now appeared like an actual head scratcher:

$$pi_t = pi^e_t + f(U_t – U^*) + O
f'(U_t – U^*)

The place: 

• πₜ represents the inflation fee at time t
• πᵉₜ represents the anticipated inflation at time t
• U represents the unemployment fee at time t
• U* represents the “pure” fee of unemployment 
• f is a perform that describes an inverse relationship
• Ο (omicron) represents provide shocks at time t
• ₜ₋₁ represents the time earlier to the present time t
• λ represents the burden given to current noticed inflation when forming expectations
• (1-λ) represents the burden given to earlier inflation expectations when forming new expectations

By the late Seventies, the economics career had accomplished its pivot. Textbooks have been rewritten. Lectures have been up to date. The brand new consensus emerged: there was a short-run Phillips curve (the place surprising inflation may quickly scale back unemployment) however no long-run trade-off. This allowed economists to keep up the essential framework of the Phillips curve whereas explaining away its failures. The brand new components had misplaced its authentic strengths of being easy and potential to measure, nonetheless, over time these had come to be extra curses than items. What in the end secured the Phillips curve’s enduring affect was not these preliminary attributes, however their substitute: resistance to being confirmed incorrect.

If unemployment and inflation weren’t behaving as predicted, it could be as a result of expectations had modified or that the “pure fee” of unemployment had shifted. How do economists measure these variables? They’ll’t, so that they infer them from… the unemployment and inflation information. A fantastically round argument, which has resulted in no additional vital modifications within the mannequin to the current day.

Pseudo-Science and Un-falsifiability

The idea of unfalsifiability was popularised by thinker Karl Popper, who argued that the power to be falsified is what separates scientific theories from pseudo-scientific ones. This merely implies that if a concept can’t be examined in a means that may show it incorrect, it’s not scientific. That additionally goes for theories that bend and shift to accommodate any potential proof towards them.

If I inform you there’s a spaghetti monster dwelling on the dark-side of the Moon, what would you suppose? In all probability that I’m a nut job. However shall we say I’m considered an knowledgeable within the subject of monsters. I’ve constructed up a plethora of mathematical equations, scientific charts, textbooks that might construct a home, and most significantly a loyal fanbase, together with most of the most senior figures in authorities defence departments, who’re eager to arrange for any alien assaults — and an even bigger funds that goes together with it. 

Would you genuinely nonetheless suppose I used to be a nut job? Maybe you’ve simply missed one thing in all of the jargon. In any case, there are numerous effectively thought of people that consider it. You don’t wish to be considered a nut job your self, do you? Possibly it’s finest to only associate with what the specialists say.

Persevering with the analogy, a workforce of scientists strap themselves to a rocket in an effort to search out the spaghetti monster, however it’s nowhere to be seen. Certainly that’s proof the spaghetti monster doesn’t exist, proper? Ah, not fairly, it seems one of many many equations was lacking a small variable… give the specialists a second… 1,2,3… tah da! That’s fastened the issue. It seems the spaghetti monster is definitely invisible, therefore why the scientists didn’t discover it. 

I’m positive most of you studying that received the message lengthy earlier than attending to the top of that foolish story — sorry, it was an excessive amount of enjoyable to put in writing. Everyone knows of actual life eventualities the place this kind of considering occurs: Freudian psychoanalysis, conventional Chinese language drugs, crystal therapeutic, chiropractics… the checklist goes on. Sadly, as a passionate financial thinker, I’m ashamed to say a core mannequin of macroeconomics additionally belongs on that checklist.

The very fact is, time and time once more economists have been given the chance to reject the Phillips curve, however as an alternative proceed to offer it extra caveats and excuses. I’m of the idea that there isn’t any conceivable situation which might trigger mainstream macroeconomics to essentially go away behind the Phillips curve. As such, it’s by definition un-falsifiable and subsequently pseudo-science.

Continued Reputation

Grasp on. This could’t be proper. Tutorial professors, skilled economists, and central financial institution heads are all sensible folks. How may they probably be fooled in believing in a pseudo-scientific thought?

One of many clearest recollections I’ve at college was in my second-year of my economics diploma. The ultimate lecture of the module “Macroeconomics II” was coming to a detailed. After a troublesome two hour slog sitting in a stuffy lecture corridor, making an attempt my finest to maintain awake, not to mention deal with the dry energy level slides, the lecturer switched off the presentation, and casually stated one thing alongside the strains:

“…and that’s every part that we have to cowl on your examination. When you really feel confused as to how all this is smart in the true world, don’t fear. Nobody actually is aware of if any of those fashions actually work.” 

It was an absolute bombshell second for me. Beforehand, I had thought that I used to be nonetheless a dumb pupil who simply hadn’t “received it” but. What my lecturer was saying, in other-words, is that the specialists all realize it’s pseudo-science. 

The comply with up query is, after all, why do they preserve pushing these fashions?

I can solely theorise, however I’d say it’s as a result of it retains all of them busy. Minimize out 10% of macroeconomics textbooks and what occurs? 10% much less content material to show, 10% discount in analysis grants, 10% fewer macroeconomists. Why name out the emperor’s new garments if you’re the emperor?

In closing, we are able to’t depend on specialists to inform us if the Phillips curve is a sham, or certainly any specialists’ concept whose fame or livelihood depends upon its validity. It’s as much as us to make that discovery. The snake oil salesman doesn’t promote his product as a result of he believes in it, however as a result of his prospects do.

Endnotes

¹ The “Phillips curve” didn’t fairly beat the “IS curve” on this event, which was talked about on 82 pages!

² Apparently, Samuelson and Solow would have discovered no curving relationship had they determined to match common value inflation and unemployment utilizing Phillips’ authentic 1861 to 1957 U.Okay. information, slightly than their new U.S. information. Debatable, if that they had, the Phillips curve may by no means have existed outdoors of some dusty journals.

³ I discover this a humorous alternative of phrases, I find yourself imagining a policymaker coming to the chief of the free world and saying:

“Good night Mr. President. Did you take pleasure in final 12 months’s economic system? Would possibly we endeavour to introduce some selection this 12 months? I’ll show most helpful to at least one’s election prospects. One thing like a rise in inflation by 1% to push down unemployment to five%, maybe?”

⁴ H.A. Hayek had raised points about to the long-run Phillips curve and expectations far sooner than Friedman and Phelps. For instance, he famous “the stimulating impact of inflation will … function solely as long as it has not been foreseen; as quickly because it involves be foreseen, solely its continuation at an elevated fee will keep the identical diploma of prosperity” in his ebook The Structure of Liberty, revealed in 1960. The rationale Friedman and Phelps turned so well-known for his or her critique was not their novel insights, however their willingness to change the Phillips curve mannequin, slightly than a complete rejection.