The debate of the relationship between inflation and unemployment is mainly based on the famous “Phillips Curve”. This curve was first discovered by a New Zealand born economist called Allan William Phillips. In 1958, A. W. Phillips published an article “The relationship between unemployment and the rate of change of money wages in the United Kingdom, 1861-1957”, in which he showed a negative correlation between inflation and unemployment (Phillips 1958). As shown in figure 1, when unemployment rate is low, the inflation rate tends to be high, and when unemployment is high, the inflation rate tends to be low, even to be negative.
In a 1958 article that was to become a frequently cited reference in the
economics literature, economist A.W. Phillips reported evidence of an inverse
relationship between the rate of increase in wages and the rate of unemployment.
Comparing rates of increase in wages with unemployment rates in Britain between
1861 and 1957, Phillips found that as the labor market tightened, and the
unemployment rate fell, money wages tended to rise more rapidly. Because wage
increases are closely correlated with price increases, that relationship was widely
interpreted as a trade-off between inflation and unemployment.2
The implication was
that, given a trade-off between inflation and unemployment, policymakers could
"buy" a lower rate of unemployment at the cost of a higher rate of inflation.
The curve describing this trade-off became known as the "Phillips curve." A
stable Phillips curve would mean that policymakers might choose one among several
combinations of inflation and unemployment rates that seemed to be most palatable
and set that as the goal of macroeconomic policy. The U.S. experience of the 1960s
did little to disprove that view.