The Phillips Curve is one of the most fundamental concepts in macroeconomics, illustrating the inverse relationship between inflation and unemployment. Named after economist A.W. Phillips, this curve has been widely studied, debated, and modified over time, especially in the face of changing economic conditions.

In this blog post, we’ll explore:

• The origins of the Phillips Curve
• Its theoretical implications
• The breakdown of the original relationship
• Modern perspectives on inflation and unemployment
• The impact of Donald Trump's 2025 tariff policy on the Phillips Curve

1. The Origins of the Phillips Curve

In 1958, New Zealand-born economist A.W. Phillips published a paper analyzing data from the United Kingdom (1861–1957) and found a negative correlation between wage inflation and unemployment. The idea was simple:

• When unemployment is low, employers must compete for workers, driving up wages.
• When unemployment is high, job seekers are abundant, reducing the pressure on wages.

Later, economists like Paul Samuelson and Robert Solow expanded this idea to show a direct link between inflation (general price level increases) and unemployment.

This suggested a trade-off between inflation and unemployment: lower unemployment came at the cost of higher inflation, and vice versa.

2. The Breakdown of the Original Phillips Curve

While the Phillips Curve held up well in the 1950s and 1960s, it broke down in the 1970s, largely due to the phenomenon of stagflation—the coexistence of high inflation and high unemployment.

This was unexpected based on the original theory. The 1970s oil shocks, combined with changes in monetary and fiscal policies, led to:

• Rising inflation due to supply shocks (e.g., oil prices)
• Persistent unemployment despite inflation

The rational expectations theory, developed by economists like Robert Lucas, and the natural rate hypothesis, introduced by Milton Friedman and Edmund Phelps, provided alternative explanations. They argued that:

• In the long run, unemployment is determined by structural factors (such as labor market policies and productivity) rather than inflation.
• If people expect high inflation, businesses and workers adjust their behavior, neutralizing the short-term trade-off.

This led to the expectations-augmented Phillips Curve, where inflation expectations play a crucial role.

3. Modern Perspectives on the Phillips Curve

A Flattening Curve?

In recent years, economists have debated whether the Phillips Curve has become flatter, meaning inflation and unemployment are now less correlated. Possible reasons include:

• Globalization: Wages and prices are influenced by global rather than local conditions.
• Technological advancements: Automation and digitalization change labor market dynamics.
• Anchored inflation expectations: Central banks' credibility in managing inflation has led to stable inflation expectations, weakening the trade-off.

Phillips Curve in the Post-Pandemic Era

The COVID-19 pandemic and its aftermath introduced new challenges:

• Supply chain disruptions led to inflation despite high unemployment in 2020.
• Labor shortages and wage pressures in 2021–2023 fueled inflation, even as unemployment fell.

Central banks, particularly the Federal Reserve, now focus on a data-driven approach, considering multiple factors beyond the traditional Phillips Curve.

4. The Impact of Donald Trump’s 2025 Tariff Policy on the Phillips Curve

In 2025, current U.S. President Donald Trump announced new tariff policies aimed at reducing trade deficits and promoting domestic manufacturing. These policies include higher tariffs on Chinese, Mexican, Canada imports, significantly impacting global trade.

How Do Tariffs Affect Inflation and Unemployment?

1. Higher Inflation Due to Increased Import Costs

   • Tariffs act as a tax on imported goods, raising the prices of products like electronics, vehicles, and consumer goods.
   • This cost increase gets passed on to consumers, fueling cost-push inflation—where inflation rises due to higher production costs rather than increased demand.
   • According to NPR, American consumers are likely to see increased costs for various goods as a result of these tariffs.

2. Unemployment Effects Depend on Industry

   • Some domestic industries may benefit as tariffs make foreign goods more expensive, encouraging local production and hiring.
   • However, other industries that rely on imported components may struggle with higher costs, leading to layoffs or slower job growth.
   • Export-oriented industries may face retaliatory tariffs from other countries, hurting American manufacturers and reducing jobs.
   • A Brookings Institution analysis suggests that tariffs could negatively impact all three economies involved—Mexico, Canada, and the U.S..

How Does This Influence the Phillips Curve?

• Short-Term Impact: The trade-off between inflation and unemployment may become more pronounced. Higher inflation from tariffs could coincide with higher unemployment in affected industries, moving the economy towards stagflation-like conditions.
• Long-Term Impact: If businesses adapt by reshoring production and investing in automation, structural changes could flatten the Phillips Curve further, reducing the inflation-unemployment link.
• Policy Response: The Federal Reserve may need to tighten monetary policy (raise interest rates) to combat inflation, which could slow economic growth and increase unemployment. S&P Global Ratings has indicated that these tariffs might necessitate revisions to the U.S. economic forecast.

Overall, Trump’s tariff policies in 2025 could disrupt the traditional Phillips Curve relationship, making it harder to predict the inflation-unemployment trade-off.

5. Policy Implications

The Phillips Curve has shaped economic policies for decades. Here’s how:

• Monetary Policy: Central banks use interest rates to balance inflation and unemployment, though they now acknowledge inflation is influenced by supply-side factors too.
• Fiscal Policy: Governments use stimulus programs to boost employment but must be cautious of inflationary pressures.
• Trade Policy: Tariffs, supply chain dynamics, and globalization must be factored into inflation and labor market policies.
• Labor Market Policies: Investments in education, training, and labor mobility can reduce the natural rate of unemployment.

Conclusion

While the Phillips Curve remains a useful framework, its traditional inverse relationship between inflation and unemployment is no longer as straightforward. Structural changes in the economy, globalization, and inflation expectations all influence modern policymaking.

Donald Trump’s 2025 tariff policies further complicate the Phillips Curve, introducing supply-side inflation pressures while affecting employment dynamics across industries. Policymakers must now consider a broader set of factors, including trade policy, supply chains, and monetary interventions, when managing inflation and unemployment.

What do you think? Is the Phillips Curve still relevant in today’s economy? Let’s discuss in the comments! 🚀