Phillips Curve

What Is the Phillips Curve?

The Phillips Curve, named after economist A.W. Phillips who documented it in 1958, describes the empirical relationship between unemployment and wage (and later price) inflation. The original finding: when UK unemployment was low, wage growth was high; when unemployment was high, wage growth was low.

Central banks use this relationship to calibrate policy: if the labour market is "too tight" (unemployment too low), they expect inflation to rise and may need to raise rates to cool the economy.

NAIRU: The Non-Accelerating Inflation Rate of Unemployment

A key concept derived from the Phillips Curve is NAIRU — the unemployment rate below which inflation would begin to accelerate. The Fed estimates this at roughly 4–4.5% in the US. When unemployment falls significantly below NAIRU, the Fed worries about overheating and considers tightening.

The Flat Phillips Curve Problem

From the mid-1990s to 2020, the Phillips Curve appeared to "flatten" dramatically — unemployment could fall very low without much inflation. Multiple explanations were offered:

• Globalisation suppressing wage growth
• Anchored inflation expectations
• Technological deflation
• Labour market slack not captured by headline unemployment

The flat Phillips Curve contributed to the Fed keeping rates near zero for many years, which some argue was a policy error.

Post-COVID Revival

COVID disrupted the labour market in unprecedented ways. When unemployment fell sharply from the pandemic peak, inflation surged — suggesting the Phillips Curve relationship had reasserted itself. The "non-linear" Phillips Curve theory (flat when unemployment is near equilibrium, steep when well below NAIRU) gained traction.

Trading Implications

Strong NFP prints or low unemployment data → market fears inflation → bonds sell off, Fed expected to hike. Weak jobs data → disinflation expected → bonds rally, Fed expected to cut.