Philips Curve

JAN 20

Preliminary   > Economic Development   >   Indian Economy and Issues   >   Basics

WHY IN NEWS?

The retail price inflation has increased to a nearly six-year high of 7.35% in December 2019, raising worries that the Indian economy may be headed towards stagflation.

ABOUT PHILIPS CURVE

  • The Phillips curve is an economic concept developed by A. W. Phillips stating that inflation and unemployment have a stable and inverse relationship. The theory claims that with economic growth comes inflation, which in turn should lead to more jobs and less unemployment.

 

  • The inverse relationship between inflation and unemployment was seen as a confirmation of the hypothesis that inflation helps the economy function at its full potential.
  • Inflation, by boosting nominal wages can encourage workers in an economy to accept lower real wages. The employment and production capacity increases boosting economic growth.
  • Without inflation, workers would be unwilling to accept lower real wages, which in turn would lead to higher unemployment and decreased output in the economy
  • However, at inflation rates beyond a certain level, at which point labour and other resources in the economy are fully employed, inflation will have no employment or growth benefits.
  • Accordingly, policymakers are often advised to maintain a certain inflation rate to ensure that unemployment is kept to a minimum and the economy is operating at full capacity.

About Stagflation

  • Stagflation is an economic scenario where an economy faces both high inflation and low growth (and high unemployment) at the same time.
  • Stagflation challenges the conventional view that inflation helps an economy operate at full capacity.
  • The stagflation crisis in the United States in the 1970s, caused by rising oil prices, led many to question the validity of the Phillips Curve.

Prelims Question

Q. ‘Phillips curve is based on statistical studies of which among the following variables?
a)Unemployment and GDP growth rate
b)Inflation and GDP growth rate
c)Unemployment and Poverty
d)Inflation and Unemployment

Answer to the Prelims Question