- The Phillips Curve, founded by economist A.W. Phillips, has been taught in macroeconomics and used by policymakers to help shape monetary policy. In 1958, A.W. Phillips examined unemployment and wage inflation and determined that an inverse relationship between the two existed. His research paper demonstrated that inflation is higher when unemployment is low and lower when unemployment is high. Since the release of his paper in the late 1950s, this relationship today has extended to price inflation and unemployment.
- It is evident that a tradeoff between U.S. inflation, as measured by the consumer price index (CPI), and the U.S. unemployment rate is present over the period depicted in the chart above.
- Between 1978 and 1979, rising energy prices contributed to a sharp increase in U.S. inflation. To curb this rise, aggressive interest rates hikes, and the tightening of money supply were steps enacted by then Federal Reserve chair, Paul Volcker; a period known as the “Volcker Shock.” Approximately three years later, and as a result, CPI dropped to 2.4% from its 1980 peak of 14.6% and unemployment rose to over 9.0%.
- As the U.S. economy recovered from the effects of COVID-19, the unemployment rate drastically fell from its April 2020 peak of 14.7%, but inflation rapidly ascended. The Federal Reserve aggressively hiked interest rates over 2022 with the hope they can bring inflation back down to their 2.0% target, a strategy reminiscent of the “Volcker Shock.”
- As of early November 2022, the Effective Federal Funds rate reached 3.8% from 0.1% at the start of the year, CPI had fallen from a high of 9.0% in June 2022 to 7.8% in October 2022, and the unemployment rate remained 20bps below where it was at the start of the year (3.9%).
- Do you believe that the Federal Reserve can still achieve a “soft landing” by following the principles of the Phillips Curve?v
The Phillips Curve
December 10, 2022 2 minutes read
