The Phillips Curve: Inflation and Unemployment

This chapter discusses one of the fundamental relationships in macroeconomics, namely the trade-off between inflation and unemployment known as the Phillips Curve. It analyzes the early empirical findings of A. W. Phillips (1958) regarding the negative relationship between wage growth and unemployment in the United Kingdom over the period 1861–1957, as well as the evolution of this concept into the inflation–unemployment trade-off in modern macroeconomic policy. The discussion continues with the policy dilemma faced by policymakers: the choice between pursuing full employment with the risk of high inflation or maintaining price stability with the risk of high unemployment. Employing Milton Friedman's (1968) framework of the natural rate of unemployment and the concept of a vertical long-run Phillips Curve, this chapter demonstrates that the inflation–unemployment trade-off is only temporary. Furthermore, this chapter explores the role of inflation expectations in determining wage dynamics, drawing on the work of Edmund Phelps (1967) on adaptive expectations in wage setting. In the final section, the chapter connects these macroeconomic concepts to human resource management practices in managing employees' expectations regarding annual salary increases. The findings indicate that well-managed expectations can reduce upward wage pressure without sacrificing employee satisfaction. This chapter presents three visual elements: Phillips' (1958) original Phillips Curve graph, a diagram of the short-run versus long-run Phillips Curve, and a table of HR management communication strategies for managing salary expectations.