Inflation or unemployment that is the question

What does the Phillips curve say about inflation and unemployment, what criticisms did it receive after the stagflation of the 70s, and does it hold true in Argentina between 1974 and 2021? Report from November 2022.

The dilemma between inflation and unemployment is presented in economic literature through what is known as the Phillips Curve . This means that, under this model, it is not possible to achieve the goal of setting both rates to zero simultaneously. The only option is to "control" one of these economic problems, either inflation or unemployment.

This inverse relationship was proposed under a certain empirical regularity that is described for the United Kingdom between 1861 and 1913. This model, which was popular for a certain period of time, was criticized and modified by different economists, with greater or lesser empirical correlation.

This article first presents the original model proposed by Phillips, along with its background and the reasons for its popularity. It also examines various criticisms of this relationship and modifications to the original model. Additionally, it offers a brief analysis of the model's application to the Argentine economy and concludes with some final comments on the discussion.

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What does the Phillips curve say?

The Phillips curve is named after Alban William Phillips (1914-1975), in recognition of his work on unemployment and nominal wages, published in November 1958. In it, an inverse and stable relationship between these variables is identified.

This is represented by a two-dimensional graph. The x-axis represents the unemployment rate, and the y-axis, the inflation rate. The negative relationship suggests a trade-off between these two economic phenomena. Again: to reduce the general increase in prices, it is necessary to sacrifice some employment, and vice versa.

Theoretical Phillips curve: inverse relationship between the inflation rate and the unemployment rate, with two marked points
Curva de Phillips teórica: a menor desempleo, mayor inflación.

The elaboration and theoretical justification of Phillips' empirical finding was not done by him, but is based on a 1960 paper by Richard Lipsey. And it was reinforced in that same year by a work published by Robert Solow and Paul Samuelson, in which they also identified a negative relationship between inflation and unemployment for the United States and named the curve as such for the first time.

Criticisms of the model

This model certainly faced criticism from both theoretical and empirical perspectives. Indeed, the international context of the 70s disrupted the previously discussed inverse relationship between inflation and unemployment, as both high inflation and unemployment rates emerged in a new phenomenon known as stagflation. From a theoretical standpoint, the criticisms of Friedman and Phelps are examined first, followed by the contributions of Lucas and Sargent, and finally the comments of Tobin.

The Phillips Curve in Argentina, 1974-2021

The empirical correlation in Argentina can be traced back to 1974, the date of the first official data. The series presented covers 1974–2021, spanning different political regimes and even different currencies. As a technical note, a second-order polynomial trend line was used to project the trend line derived from the observations. This is a curved line used when the data fluctuates, characterized by having only one peak or valley. It is roughly equivalent to the shape of a parabola.

In general, both the annual and quarterly data appear to agree on the empirical regularity of the Phillips curve. However, for the graph to fit the theory, the right tail of the curve should not increase. This is possibly due to periods of stagflation, a recurring situation in recent years and—especially—during the 80s.

Inflation rate and unemployment rate in Argentina with annual and quarterly data, and its trend line
Inflación y desempleo en Argentina, con datos anuales y trimestrales y su línea de tendencia.

In the report, we review in more detail both the theoretical and empirical development, as well as each of the criticisms discussed. We also analyze different sub-periods for the Argentine economy. We invite you to read the full report to learn more about the Phillips Curve.

Open access, for use and citation

The report is available freely and without charge, under a Creative Commons license (CC BY-NC-SA 4.0):

Inflación o desocupación, esa es la cuestión. Informes del Observatorio UNR N.º 59 — Serie Puente Académico N.º 17, noviembre de 2022. ISSN 2683-9067 / 2683-9091. Autores: Alfredo O. Bula, Patricio H. Almeida Gentile, Luciano A. Jara Musuruana y Germán A. Tessmer.