Phillips curve: tradeoff and macro signal explained
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By Ken Chigbo, Founder, KenMacro. Published 2026-05-13.
Quick answer
The Phillips curve describes an inverse relationship between unemployment and inflation. When joblessness falls, wage and price pressures tend to rise, and vice versa. Central banks reference it when calibrating policy, though the relationship has flattened in recent decades, weakening its predictive power for short-term inflation forecasting.
What is Phillips curve?
The Phillips curve is an empirical observation, first published by economist A.W. Phillips in 1958, showing that lower unemployment in the United Kingdom historically coincided with faster wage growth. The framework was later extended to consumer price inflation and reshaped by Milton Friedman and Edmund Phelps, who introduced inflation expectations and the concept of a non-accelerating inflation rate of unemployment, often abbreviated as NAIRU. The modern version distinguishes between a short-run curve, where the tradeoff exists, and a long-run vertical curve, where monetary policy cannot permanently lower unemployment without accelerating inflation.
How traders use Phillips curve
The desk treats the Phillips curve as a structural lens rather than a tactical signal. When the unemployment rate prints well below estimates of NAIRU, traders position for hawkish central bank rhetoric, firmer front-end yields, and currency strength in the affected economy. Federal Reserve speakers, including the Chair, routinely reference labour market slack and wage growth when justifying policy moves, so the framework underpins FOMC communication. Institutional desks pair non-farm payrolls, average hourly earnings, and the employment cost index with CPI prints to gauge whether the curve is steepening or flat. Retail traders often misuse it by assuming a tight one-to-one link; in practice, the slope has weakened, and inflation expectations, supply shocks, and productivity now dominate short-horizon outcomes.
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Common misconceptions about the Phillips curve
Three errors recur on the retail side. First, traders assume the curve guarantees inflation whenever unemployment falls, ignoring that the post-2010 relationship in the United States and euro area flattened significantly. Second, many conflate the short-run and long-run versions; Friedman's natural rate hypothesis implies no permanent tradeoff exists. Third, some treat NAIRU as a fixed number, when central bank estimates revise regularly and carry wide confidence intervals. The desk also notes that supply-driven inflation, such as energy shocks, sits outside the framework entirely and can decouple price growth from labour market conditions for extended periods.
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Frequently asked
Is the Phillips curve still relevant today?
It remains a core teaching framework and is still referenced by central bank officials, including Federal Reserve and European Central Bank speakers. However, the empirical slope flattened materially after the 1990s, and the 2021 to 2023 inflation surge revealed that supply shocks and inflation expectations can dominate. The desk views it as one input among many, useful for understanding policy reaction functions but unreliable as a standalone forecasting tool for near-term inflation.
What is NAIRU in the Phillips curve framework?
NAIRU stands for the non-accelerating inflation rate of unemployment. It is the unemployment level consistent with stable inflation. When actual unemployment falls below NAIRU, the framework predicts rising inflation; when it sits above, disinflation should follow. Estimates vary by institution and country, and the Congressional Budget Office, IMF, and OECD publish their own figures. The concept underpins how central banks judge labour market tightness when setting policy rates.
Why did the Phillips curve break down in the 1970s?
The 1970s stagflation, where high unemployment coexisted with high inflation, contradicted the simple tradeoff. Friedman and Phelps had already argued that workers and firms adapt their inflation expectations, shifting the short-run curve upward. Oil supply shocks compounded the problem. The episode forced economists to distinguish between expected and unexpected inflation and produced the expectations-augmented Phillips curve, which remains the textbook version taught in graduate macroeconomics today.
How do bond traders use the Phillips curve?
Fixed income desks use the framework to anticipate central bank reactions to labour data. A sharp drop in unemployment alongside firm wage growth typically prompts repricing of the front-end curve toward higher rates, steeper hike expectations, and wider real yield differentials. Conversely, rising unemployment with cooling earnings supports cuts and bull-steepening. The desk pairs these reads with breakeven inflation moves and survey-based expectations to filter genuine signals from noise.
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