Researcher A.W. Phillips discovered Phillip's curve after using British data to study the relationship between the unemployment rate and fluctuations in nominal wage rates. Since wage rates react in a similar way to inflation, his findings concluded that there is a negative correlation between the inflation rate and unemployment rate. This model is more of a single-equation economic model with two independent variables. It does not clearly depict the relationship between these two variables, other than a correlational one. Why? This is because there need to be more variables that affect inflation and unemployment if it were to hold. A multivariate model would be more appropriate to determine the relationship between unemployment and inflation. Introduction of independent variables such as inflation expectations and supply shocks such as a decrease in relative prices of energy, foods and imports would improve the model.
Graph (a) depicts this kind of relationship. The curve implies that a lower unemployment rate could be maintained forever as long as people are willing to pay the price of a higher inflation rate. However, the concept may not necessarily hold in the long-run. In the long run, the unemployment rate will not be affected by changes in the price level. When unemployment reaches its natural rate, this means there will be consistency in prices and wage decisions. The consequence of this would be Phillip's curve that is vertical at the natural rate of unemployment.
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However, in the 1990s, U.S data on the inflation rate and unemployment rate depicts an upward relationship. This contradicts Phillip's curve. This implies that it is possible to have periods characterized by both lower inflation and falling unemployment rates. Increased competition which prevents producers from increasing prices coupled with efficient monetary policies which compel people to reduce their expectations of future inflation.
As postulated in the 1960s, Phillip's curve is a clear example of correlation not being causation. This is because the economic growth that accompanies accelerated inflation is only a side effect but not its cause and vice versa. This implies that the increase in employment and GDP does not lead to inflation but is statistically associated with it in terms of correlation.
Clearly, the tradeoff postulated by Phillip's curve does not exist. Labor demand curves show that there is a positive correlation between the rate of employment and nominal wage rates. This means that when the unemployment rate is low, very many people are employed at a relatively lower wage rate. The high unemployment rate means the few people who are in active employment receive relatively higher wages. This is the exact opposite of what the Phillips concept suggests
References
Phillips, A. W., & Leeson, R. (2000). The relation between unemployment and the rate of change of money wage rates in the United Kingdom, 1861-1957. In A. W. H. Phillips: Collected works in contemporary perspective (pp. 243-260). Cambridge University Press. doi.org/10.1017/CBO9780511521980.027
