Phillips curve (relationship between inflation and unemployment

level)
A noted British economists, A.W. Phillips published an article in 1958 based on his
good deal of research using historical data from the U.K. for about 100 years in
which he arrived at the conclusion that there in fact existed an inverse relationship
between rate of unemployment and the rate of inflation. This inverse relation
implies a trade-off, that is, for reducing unemployment, price in the form of a higher
rate of inflation has to be paid, and for reducing the rate of inflation, price in terms
of a higher rate of unemployment has to be borne. On graphically fitting a curve to
the historical data Phillips obtained a downward sloping curve exhibiting the inverse
relation between the rate of inflation and the rate of unemployment and this curve
is now named after his name as Phillips Curve.
The Phillips curve is shown in the figure below where along the horizontal axis the
rate of unemployment and along the vertical axis the rate of inflation is measured.
It will be seen that when rate of inflation is 6 percent, the unemployment rate is 2
percent, and when rate of inflation is reduced to 4 percent per annum, say by
pursuing contractionary fiscal policy and thereby reducing aggregate demand, the
rate of unemployment increases to 7 percent of labour force. The actual Phillips
curve drawn from the data of sixties (1961- 69) for the United States also shows the
inverse relation between unemployment rate and rate of inflation. Such empirical
data pertaining to the fifties and sixties for other developed countries seemed to
confirm the Phillips curve concept. On the basis of this, many economists came to
believe that there existed a stable Phillips curve which depicted a predictable
inverse relation between inflation and unemployment. Further, on the basis of a
stable Phillips curve for a country, they emphasized the trade off that confronts the
economic policy makers. This trade off presents a dilemma for the policy makers;
should they choose a higher rate of inflation with lower unemployment or a higher
rate of unemployment with a low inflation rate.