In economics, the Phillips curve is a graphical representation of the idea that there exists an inverse relationship between inflation and unemployment. In a standard Phillips curve diagram, the inflation rate or price level is plotted on the vertical axis, and the rate of unemployment on the horizontal.
In the 1970s and 1980s, monetarists such as Milton Friedman argued that the Phillips curve was an example of the inability of Keynesian economics and demand-management policies to account for or address the phenomenon of supply-side (cost-push) inflation or "stagflation." In other words, supply-siders were of the belief that the model could not adequately describe inflation that resulted from sources other than excess demand in the economy, such as exogenous supply shocks (sudden disruptions to supply).
The key problem, however, was primarily that the Phillips curve lacked a distinction between the short run and long run timeframes. As the accompanying diagram shows, changes in the structure of the economy (such as those caused by exogenous supply shocks) shift the short-run Phillips curve either up or down, such that any given level of unemployment corresponds to a higher or lower price level. According to this view, the inverse relationship between inflation and unemployment still holds, though the precise values of each that correspond to one another at any given short-run equilibrium may vary when supply side effects are at work.
The Long-Run Phillips curve (LRPC) is drawn as a vertical line at the NAIRU (the Non-Accelerating Inflation Rate of Unemployment), and exemplifies the idea (adopted primarily by neoclassical economists) that in the long run, the natural rate of unemployment will remain constant at the NAIRU, though the corresponding rate of inflation may change over time.
Anomaly in 2017
The lack of any correlation between the tightening labor market and inflation in 2017 suggests that the Phillips curve is not true. "Deflationary competitive pressures could have become more important for the overall trend in prices than the so-called Phillips Curve relationship, which links inflation to the state of the labor market. That model, coined almost 60 years ago, is the basis for the Fed’s outlook for continued gradual rate increases." Wage growth is a necessary component of inflation, and without wage growth a drop in unemployment seems insignificant in predicting inflation.