Phillips curve

What is the Phillips curve

The Phillips curve is the idea that, in the short run, lower unemployment tends to come with higher inflation, and higher unemployment with lower inflation.

It is named after the economist A. W. Phillips, who found this pattern in wage data. On a chart, unemployment sits on the horizontal axis and inflation (or wage growth) on the vertical axis. The line slopes downward.

The reasoning is simple. When few people are out of work, employers compete for staff and raise wages. Firms then pass higher labour costs into prices. When many people are unemployed, wage pressure weakens and price growth slows.

A worked example (hypothetical)

Imagine an economy where unemployment falls over a year because demand is strong. Factories run full shifts, and skilled workers are hard to find.

• Employers offer higher pay to keep and hire staff.
• Higher wage bills push firms to raise prices.
• The inflation rate climbs above the central bank's target.

The economy has moved up and to the left along its Phillips curve. Lower unemployment came with higher inflation.

The central bank may respond by raising its policy rate. Borrowing becomes more expensive, demand cools, hiring slows, unemployment drifts up and inflation eases. The economy moves back down the curve.

The formal definition

Economists today mostly use the expectations-augmented Phillips curve:

π = πᵉ − β(u − u*) + ε

• π: actual inflation
• πᵉ: expected inflation
• u: actual unemployment rate
• u*: the natural rate of unemployment, often called NAIRU (the non-accelerating inflation rate of unemployment)
• β: how strongly inflation reacts to the unemployment gap
• ε: supply shocks, such as oil price jumps

Edge cases and limits

• Long run. If people come to expect higher inflation, the trade-off disappears. The long-run Phillips curve is usually drawn as a vertical line at u*.
• Stagflation. Supply shocks can raise inflation and unemployment at the same time. The simple curve cannot explain this.
• Flat curve. In some periods inflation barely reacts to unemployment. Credible central banks and anchored expectations are common explanations.
• Emerging markets. In economies such as Pakistan, inflation often depends more on the exchange rate, energy prices and food supply than on the labour market. A currency depreciation can lift prices regardless of unemployment.

Where you see the term

• Central bank statements. Monetary policy statements discuss the output gap, demand pressure and inflation expectations, which is Phillips curve reasoning. The State Bank of Pakistan's latest decision: SBP policy rate raised by 50 bps to 12% with effect from 27.10.2026 (MPC).
• Economic news. US jobs reports and wage data are often read through this lens. Markets ask whether a tight labour market will keep inflation high and interest rates up.
• Trading platforms. Economic calendars list unemployment, wage and inflation releases. Prices of currency pairs, gold and stock indices can move sharply around them. The curve itself does not appear on a chart.

The Phillips curve describes a tendency, not a rule. It does not tell you how any market will move. Leveraged CFD and forex trading around data releases can lose money fast.

Related terms

• Disinflation and deflation
• Business cycle
• Basis point
• Austerity and fiscal deficit
• Fundamental analysis
• Trading glossary

Frequent questions

What does the Phillips curve mean in simple words?

When unemployment is low, inflation tends to rise. When unemployment is high, inflation tends to fall. This holds in the short run, not forever.

Does the Phillips curve still work?

Only partly. The link is weaker and less stable than it once looked, and it breaks during supply shocks and stagflation.

What is the long-run Phillips curve?

It is a vertical line at the natural rate of unemployment. In the long run, higher inflation does not keep unemployment lower.

Why do traders care about it?

Central banks use similar reasoning when they set interest rates. Rate expectations affect currencies, bonds, gold and indices.

Is NAIRU the same as zero unemployment?

No. NAIRU is the unemployment rate at which inflation stays stable. Some unemployment always exists as people change jobs.