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The trade-off between inflation and unemployment means that policymakers can reduce unemployment below its natural rate in the short run, but this will lead to higher inflation. The economy will eventually return to the natural rate of unemployment once workers have more realistic expectations about the rise in prices.
The Phillips curve is an economic theory that describes the short-term relationship between inflation and unemployment. The curve is named after economist A.W. Phillips, who studied unemployment and wages in the United Kingdom from 1861 to 1957.
The Phillips curve shows that inflation and unemployment have a stable and inverse relationship. This means that when unemployment is low, wage inflation drives up prices. When unemployment is high, spending is low, deflating the money supply as consumers reduce debt levels. The Phillips curve is important for monetary policymaking because it can help determine whether low unemployment leads to higher inflation.
Related Test: Economics 101 Practice Test: Unemployment
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