Is there a stable trade-off between unemployment and inflation, and what does it mean for policy?
Explain the short-run and long-run Phillips curve and use it to analyse conflicts between macroeconomic objectives
A focused answer to the H2 Economics learning outcome on the Phillips curve. The short-run trade-off between unemployment and inflation, why the long-run curve is vertical at the natural rate, and what this means for demand-side policy.
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What this dot point is asking
SEAB wants you to explain the short-run and long-run Phillips curve and use it to analyse conflicts between macroeconomic objectives. The central insight is that there is a short-run trade-off between unemployment and inflation but not a long-run one, which sets a fundamental limit on what demand-side policy can achieve.
The answer
The short-run Phillips curve
The short-run Phillips curve (SRPC) shows an inverse relationship between unemployment and inflation: when unemployment is low, inflation tends to be high, and vice versa. The intuition links to AD-AS: boosting AD reduces unemployment (more output, more hiring) but, near capacity, raises inflation. So in the short run there appears to be a trade-off, which is the unemployment-inflation conflict among the macroeconomic aims.
Why the short-run curve shifts: expectations
The long-run Phillips curve
In the long run, inflation expectations adjust fully to actual inflation. Any attempt to hold unemployment below the natural rate through demand stimulus only raises inflation: workers anticipate it, demand higher wages, and unemployment drifts back to the natural rate at a higher inflation rate. Repeating this just ratchets inflation up.
The result is a vertical long-run Phillips curve (LRPC) at the natural rate of unemployment. There is no permanent trade-off: in the long run, the economy settles at the natural rate whatever the inflation rate, so demand-side policy cannot permanently lower unemployment below it.
What this means for policy
- Demand-side policy can reduce cyclical unemployment and smooth the business cycle (moving along the SRPC), which is valuable in a recession.
- But it cannot permanently push unemployment below the natural rate; trying to do so only causes accelerating inflation.
- To lower unemployment in the long run, the natural rate itself must fall, which requires supply-side policy: retraining, improved labour mobility, and better incentives to work. This reconciles the apparent conflict by shifting the LRPC left rather than fighting it with demand.
Examples in context
Example 1. The stagflation lesson. The 1970s, when high inflation and high unemployment occurred together, broke the idea of a stable, exploitable Phillips-curve trade-off and confirmed the role of expectations and supply shocks. It taught policymakers that demand stimulus cannot buy permanently lower unemployment and that supply-side conditions matter, the empirical basis for the vertical long-run curve.
Example 2. Supply-side focus near full employment. An economy already near its natural rate, like Singapore, gains little lasting employment from demand stimulus and risks inflation. Lowering structural unemployment instead through retraining and labour-market measures shifts the long-run Phillips curve left, the practical application of using supply-side policy rather than demand policy to reduce the natural rate.
Try this
Q1. Describe the relationship shown by the short-run Phillips curve. [2 marks]
- Cue. An inverse relationship between unemployment and inflation: lower unemployment is associated with higher inflation, suggesting a short-run trade-off.
Q2. Explain why the long-run Phillips curve is vertical. [3 marks]
- Cue. In the long run inflation expectations adjust fully, so attempts to hold unemployment below the natural rate only raise inflation; unemployment returns to the natural rate whatever the inflation rate, giving a vertical curve.
Q3. Explain how unemployment can be reduced in the long run. [2 marks]
- Cue. By lowering the natural rate itself through supply-side policy - retraining, improved labour mobility and better work incentives - which shifts the long-run Phillips curve left.
Exam-style practice questions
Practice questions written in the style of SEAB exam questions on this dot point, with worked answer explainers. The year tag is the paper they imitate, not the source.
Original10 marksExplain the short-run Phillips curve and why the long-run Phillips curve is widely held to be vertical.Show worked answer →
A 10 mark question rewards the short-run trade-off, the role of expectations, and the vertical long-run curve.
- Short-run Phillips curve
- Shows an inverse relationship between unemployment and inflation: lower unemployment is associated with higher inflation. Boosting AD cuts unemployment but raises inflation, so there appears to be a trade-off.
- Why it shifts
- The short-run curve is drawn for a given expected inflation rate. If workers come to expect higher inflation, they bargain for higher wages, shifting the short-run curve up.
- Long-run vertical curve
- In the long run, expectations adjust fully to actual inflation, so any attempt to hold unemployment below the natural rate just raises inflation with no lasting fall in unemployment. The long-run Phillips curve is therefore vertical at the natural rate of unemployment: there is no permanent trade-off.
Markers reward the inverse short-run relationship, the expectations-driven shift, and the vertical long-run curve at the natural rate with no permanent trade-off.
Original9 marksUsing the Phillips curve, discuss the limits of demand-side policy in reducing unemployment.Show worked answer →
A 9 mark discuss question rewards the short-run gain, the long-run limit, and the supply-side conclusion.
- Short-run gain
- Expansionary demand-side policy can move the economy along the short-run Phillips curve, cutting unemployment below the natural rate at the cost of higher inflation, useful in a recession with cyclical unemployment.
- Long-run limit
- Sustained attempts to hold unemployment below the natural rate only raise expected and actual inflation, shifting the short-run curve up, with unemployment returning to the natural rate at a higher inflation rate. Demand-side policy cannot permanently cut unemployment below the natural rate.
- Conclusion
- To lower unemployment in the long run, the natural rate itself must be reduced, which requires supply-side policy (retraining, improved mobility, incentives). Demand-side policy is for cyclical unemployment and the cycle, not the structural natural rate.
Markers reward the short-run trade-off, the expectations-augmented long-run limit at the natural rate, and the conclusion that supply-side policy is needed to lower the natural rate.
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