What are the main Demerits of Phillips Curve?

The simple Phillips curve analysis suggesting a stable and permanent trade off between the prices (or wage) inflation and unemployment has been found unsatisfactory because of the following reasons:

1. Unstable Trade off:

The Phillips curve is of little value because it is unstable and not permanent. The relationship between inflation rate and unemployment rate not only varies widely across the countries but also is not stable within a given country through time.

Thus, the fact is that there exists no simple relationship between the rate of inflation and the rate of unemployment and the Phillips curve loses its explanatory power.

2. Role of Trade Unions Ignored:

Lipsy did not recognise the role of trade unions in influencing wages. The trade unions interfere in the labour market. A decrease in the unemployment rate raises the market power of the organised labour which then is used to raise wages.

This additional factor also determines the shape and position of the Phillips curve and is responsible for the shifts in the curve.

3. Influence of Cost of Living Ignored:

There is two-way relationship between wages and prices. Wages as a major element in the cost of production influence prices. But the prices through their impact on cost of living also influence wages.

The Phillips curve model considers only the effect of wages on prices and ignores the effect of prices on wages. Increase in prices causes increase in the cost of living which leads to an increase in wages.

Workers have to be compensated for a rising cost of living, whether these higher wages are negotiated with the trade unions or administered by the employer.

But this change in wages as a result of change in prices causes shifts in the Phillips curve and makes it unstable.

4. The Problem of Stagflation:

The Phillips curve which says that inflation and unemployment vary inversely remained popular during 1960s.

But, since about 1967 onwards, the major industrialised countries of the world have been experiencing high rate of inflation accompanied by a high rate of unemployment.

This new phenomenon, which is termed as stagflation, has led to the breakdown of Phillips curve and it has lost its explanatory power

5. Inflation an International Phenomenon:

The Phillips curve analysis assumes inflation as the internal problem of a country and relates it with the domestic labour market.

It ignores the fact that inflation in modern times is an international phenomenon and the domestic variables do not have much influence on it

6. Neglect of Macro Issues:

Lipsy’s analysis does not provide answer to certain macro problems: (a) it does not tell what determines the level of employment beyond which further increases in the aggregate demand lead to rising prices; (b) it does not tell what determines the rate at which wages will increase at a certain level of unemployment.

7. Johnson’s Criticism:

H.G. Johnson has criticised the Phillips curve on the following grounds:

(i) It does not provide any basic theoretical principle for the verification of which his study is to be quoted. It just assumes that the curve would have a curvilinear form and therefore it appears only a statistical artifact.

(ii) The theory behind the Phillips curve represents the crudest and least sophisticated possible economic explanation of the dynamics of economic markets in two senses:

(a) It assumes that the price adjustments in any specific market takes place with reference to the excess demand/supply in that market only and developments in other markets have no effect here.

(b) It assumes that the same theory is able to give the price adjustments in both absolute and relative terms, so that if any absolute increase in money wage takes place, it also implies a corresponding increase in wage level relative to other prices.