Economist William Phillips came up with the idea of the Phillips Curve in the 1950s. While analysing UK inflation and unemployment rates from 1860–1957, he found that when unemployment fell, inflation rose. That is; with more people employed, there was more money being spent in the economy, fanning inflation. When unemployment climbed, inflation went down. With unemployment and inflation being inversely related, economies could face either inflation or unemployment, not both. The Phillips curve looks like this.

For decades, the RBA, and other central banks around the world, exploited this relationship to control inflation via interest rates. They increased rates as employment rose (usually when the economy was expanding) and decreased rates when employment fell. But recently, the winning formula has lost its shine. In Australia, the Phillips Curve started failing around late 2013. Since then, both unemployment and inflation have fallen in together. Some of the reasons include, but are not limited to:

  • generally lower expectations for inflation rates
  • increased employer bargaining power and leverage to hold down wages due to factors like technology (robotics/AI etc.)
  • decreased unionisation
  • decreased bargaining power of employees due to things like record household debt; low family savings meaning many can’t afford even a very brief interruption to work; and rapid expansion of the need for workers to have new/updated skills
  • increased workforce casualisation
  • increased migration putting a dampener on wage growth i.e. more people available for work means more competition and lower wages
  • data not revealing the whole truth — official unemployment has floated from 4-6.3% over the last decade, but Roy Morgan research suggests 5.8-9% is more accurate.

For us in the property market, the demise of the Phillips Curve means that central banks now have less ability to control inflation by setting interest rates and the RBA may have to look at other solutions. To a degree, APRA has taken over the reigns while the RBA’s hands have been tied, and with round 1 of the Banking Royal Commission underway, the baton may be passed yet again.


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