The Phillips Curve in 2026: Why Inflation–Unemployment Tradeoffs Still Shape the Economic Landscape

Happy 2026. In this post, we will be discussing the Phillips Curve, its different models, its mathematical foundation, and its impact on government and the broad economy!

What is the Phillips Curve?

The Phillips Curve is the inverse relationship between unemployment and inflation. It models the fact that when unemployment is low, inflation is high, and when unemployment is high, inflation is low. This statistical relationship was discovered by economist A.W Phillips, and has led to decades of economic research and policy based on the relationships discovered by Phillips. With this theory being tried and tested in many countries and economies, modern economists have built on the epiphany of Phillips, and have determined that since wage behavior (how wages and employment changes over time) heavily connects to price inflation, this model can also be used to assess how slack (more people looking for jobs than there are  available) or tight (more open jobs that available people to fill them) labor markets shape inflationary trends in the broad economy. 

Long and Short run Phillips Curves

Since its discovery in 1958, the Phillips Curve has evolved into two distinct patterns reflecting different economic situations: the Short Run and the Long Run curves. The Short Run curve shows a tradeoff between inflation and unemployment in the sene that wages and prices adjust slowly off fluctuations in one another. When unemployment drops, firms are incentivized to raise wages to attract potential employees, with inflation increased as a result due to higher labor costs and increased prices as a result (decreased purchasing power). However, there is a bit of difference for a Long Run curve. The Long Run, the tradeoff between inflation and unemployment is negligible. This means that when workers adjust their expecations about inflation, their wages, and the prices of goods and services catches up in a 1:1 proportional manner, preventing a discrepancy between inflation and unemployment levels (a “natural” level). This explains why the curve of a Long Run is a vertical line, while the Short Run is not.

The mathematical foundation of the Phillips Curve?

With the Phillips Curve, the mathematical calculations are derived from wage-setting and price-setting behavior, which gets you to the equation shown above. The derivation is displayed and explained in detail below

1. Start with wage setting equation and define variables (workers care about wages based on factors- listed): Wt=Pte F(ut,z) 

• Wt: nominal wage

• Pte: expected price level

• ut: unemployment rate

• z: other factors (e.g., unemployment benefits, bargaining power)

• F(ut,z): function decreasing in ut, increasing in z

2. Establish price-setting equation and define variables (firms and companies set prices as a markup/wages): Pt=(1+μ)Wt

• Pt: price level

• μ: markup

3. (Condense the wage setting and price setting equations (gives you a ratio of actual inflation of prices vs expected inflation of prices relationship: Pt=(1+μ)Wt=(1+μ)PteF(ut,z)

4. Assume the function is linear, α>0 (sensitivity of wages) with a first-order Taylor approximation in macro to make functions manageable and easier to work with: F(ut,z)≈1+z−αut   

5. Plug a high μ and lower F value in to previous equation to yield: Pt/Pte=(1+μ)(1+z−αut)

6. Define inflation: πt=(Pt−Pt−1)Pt−1and πte≈(Pte−Pt−1)/Pt−1

7. For small changes, we can approximate (Pt/Pte≈1+πt−πte) to yield [1+πt−πte≈(1+μ)(1+z−αut)]

8. Rearrange previous inflation approximation as πt=πte+μ+z−αut

9. Define variables: 

• πt: actual inflation

• πte: expected inflation

• μ: markup (price‑setting power, the price a firm sets that is above the actual value)

• z: other cost‑push factors

• aut: pressure from unemployment in markets

Final equation: πt=πte+μ+z−αut (expectations adjusted)

Clarification: Actual inflation is the current data regarding inflation in real time, such as the BLS’ CPI data, while expected inflation is what inflation is approximated to be in the future.

This mathematical derivation shows that the equation of the Phillips curve is rooted in fundamental economic phenomena such works behavior, and firm markups, shown through the wage setting and price setting equations, then through economic assumptions and algebra, the equation for the Phillips curve. 

The impact of the Phillips curve on government activity

The Phillips curve has molded both economic activity and governmental activity since its creation. The concept has influenced governmental activity and policy because inflaiton and unemployment are interconnected and flucuate in an inverse relationship. This forces governments to act to the changes in both the labor market and in the macro economic field of inflation. A clear real world example of this came after the pandemic of 2020 (during 2021-2022). Unemployment rates fell sharply, since jobs were being made available, which caused a kickstart of the economy, which led to increased costs for firms and businesses, which led to an increase in inflation

The equation, πt=πte+μ+z−αut, presents this phenomenon mathematically: −αut decreased in magnitude, lowering the effects of inflation. At the same time, firms increased consumer prices(πte) as a result of firms facing rising wage costs (z) and therefore maintained strong markups on goods(μ). This rapid price fluctuation, fueled by movement in the labor market, led to higher inflation. 

During this time, the Fed wanted raised interest rates, a governmental action, to reduce the effects of heightened inflation and of a reduced unemployment rate. This shows how the Phillips curve relationship and equation has direct impact on the government and its policy.

Hope you enjoyed my research and commentary on the Phillips Curve. See you at the end of the month!