Why the Phillips Curve Still Matters
Reports of its death have been greatly exaggerated
The Phillips Curve didn't die. It went nonlinear.
For a generation, the Phillips Curve — the inverse relationship between unemployment and inflation — was considered a relic. Central bankers publicly questioned its relevance. Academic papers pronounced it flat, broken, or dead. Then came 2021.
The post-pandemic inflation surge coincided with the tightest labor market in fifty years. As unemployment fell below 3.5%, wages accelerated and services inflation proved stubbornly persistent. The relationship that economists had dismissed reasserted itself with uncomfortable clarity.
The Phillips Curve didn’t die. It went nonlinear.
The Nonlinearity Problem
The key insight is that the Phillips Curve is not a stable linear relationship. At moderate levels of unemployment, changes in labor market tightness have little effect on inflation. But at extremes — very tight or very loose — the relationship steepens dramatically.
Implications for Policy
If the Phillips Curve is nonlinear, then the cost of the last percentage point of disinflation may be far higher than the first. This has profound implications for central banks trying to return inflation to two percent without triggering recession.