Phillips Curve, Stagflation and NAIRU : For UPSC

Understanding the Phillips Curve and Its Implications

The Phillips Curve Concept

• The Phillips Curve, introduced by economist William Phillips in the 1950s, illustrates an inverse relationship between unemployment and inflation. When inflation is high, unemployment tends to be low, and vice versa.

• Policymakers believed they could manage unemployment through inflation control; for instance, achieving 2% unemployment would require accepting a higher inflation rate of around 10%.

• This approach was initially successful in the early 1960s but faced challenges in the 1970s when both high inflation and high unemployment occurred simultaneously.

Critique by Milton Friedman

• Milton Friedman criticized the long-term viability of the Phillips Curve trade-off, arguing that it only applied in the short term.

• He introduced the concept of "stagflation," a situation where stagnation (low GDP growth) coexists with high inflation, highlighting failures of the Phillips Curve during economic downturns.

Natural Rate of Unemployment

• Following initial successes with increased spending to reduce unemployment, policymakers recognized that there exists a natural level of unemployment that cannot be lowered indefinitely through inflation.