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:

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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