The Phillips curve is used to show the inverse relationship between the percentage rate of unemployment and
the percentage rate of inflation. The Phillips curve originated with the economist A. W. Phillips who first
observed the inverse relationship between the two variables in a study of British inflation and unemployment
between 1861 and 1957. Phillips’s study showed clearly that for Great Britain over this long time period, as
unemployment decreased, inflation increased. A hypothetical Phillips curve is shown below.
Two general theories explain inflation. The first, the demand-pull theory, says that prices increase when demand for goods and services exceeds their supply. The second, the cost-push theory, says that companies create inflation when they raise their prices to cover higher supply prices and maintain profit margins.
Some idea of what that rate of unemployment is could be extremely useful to
economic policymakers. Inflation tends to be slow to respond to those changes in
policy which affect it. The effects of an expansionary monetary policy on inflation,
for example, might not become apparent for some time. Similarly, at times when the
inflation rate is relatively high it is likely to respond only slowly to policies designed
to bring it down. In part because of this characteristic, and because policies aimed
at reducing inflation may have short-term economic costs, it seems to be the
prevalent view that it would be better to avoid increases in inflation altogether.