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Conflicts between objectives and the Phillips curve
Edexcel IAL Economics · WEC12 Macroeconomic performance and policy
Policies that help one objective often harm another. Spotting these trade-offs is central to evaluation marks.
Inflation and unemployment: the short-run Phillips curve
The short-run Phillips curve shows an inverse relationship between the rate of inflation and the rate of unemployment.
Diagram in words: inflation on the vertical axis, unemployment on the horizontal; a curve sloping down from left to right, convex to the origin.
Explanation: when AD rises, unemployment falls; labour becomes scarce, so wages rise faster, firms pass on higher costs, and inflation rises. Policies that cut inflation by reducing AD therefore tend to raise unemployment in the short run. The relationship broke down in the 1970s, when high inflation and high unemployment occurred together (stagflation), often caused by supply shocks; the trade-off is weaker if expectations adjust.
Growth and the environment
More output often means more energy use, emissions, waste and resource depletion. Green investment, carbon taxes and regulation can reduce the conflict, but may raise costs in the short run.
Inflation and the current account
Raising interest rates to reduce inflation can cause the exchange rate to appreciate, making exports dearer and imports cheaper, worsening the current account. On the other hand, rapid growth raises imports and so the current account deficit, while lower inflation than rivals improves competitiveness.
Growth and income equality
Tax cuts and deregulation to boost incentives and growth may increase inequality; higher taxes on high incomes to redistribute may reduce incentives to work and invest. Growth may benefit skilled workers and some regions more than others.
Worked example
A central bank raises interest rates sharply to cut inflation from 9% to 3%. Explain two possible conflicts this creates.
- Higher rates cut C and I, so AD shifts left: inflation falls but unemployment rises (moving along the short-run Phillips curve) and growth slows.
- Higher rates attract hot money, so the currency appreciates: exports become less competitive, worsening the current account (although lower inflation may help in the long run).
Answer: Inflation versus unemployment and growth; inflation versus current account balance.
Check yourself
- The short-run Phillips curve shows
- a positive relationship between inflation and unemployment
- the link between interest rates and investment
- the link between output and the price level
- an inverse relationship between inflation and unemployment
Show answer
an inverse relationship between inflation and unemployment. Lower unemployment tends to go with higher inflation in the short run.
- A government boosts AD to cut unemployment. According to the short-run Phillips curve,
- inflation is likely to fall
- inflation is likely to rise
- inflation is unchanged
- unemployment will rise
Show answer
inflation is likely to rise. Tighter labour markets raise wage growth and inflation.
- Stagflation in the 1970s suggested the Phillips curve trade-off
- was stronger than expected
- applied only to exports
- proved that unemployment causes deflation
- was not stable, as high inflation and high unemployment occurred together
Show answer
was not stable, as high inflation and high unemployment occurred together. Supply shocks and expectations shifted the curve.
- Higher interest rates to reduce inflation may worsen the current account because
- the currency appreciates, making exports less competitive
- imports become more expensive
- consumers buy more domestic goods
- exports become cheaper abroad
Show answer
the currency appreciates, making exports less competitive. Higher rates attract capital inflows and raise the exchange rate.
- Which policy could reduce the conflict between growth and environmental protection?
- Removing all pollution regulations
- Cutting fuel taxes
- Subsidising investment in renewable energy
- Subsidising coal power stations
Show answer
Subsidising investment in renewable energy. Green investment can allow output to grow with fewer emissions.
- Cutting the top rate of income tax to improve incentives and growth may conflict with
- greater income equality
- low unemployment
- economic growth
- higher labour productivity
Show answer
greater income equality. The richest gain most from a top-rate cut, widening inequality.
- Explain why the short-run Phillips curve slopes downwards.
Show answer
As unemployment falls, labour becomes scarcer, so workers can bargain for higher wages; firms pass these higher costs on as higher prices, so inflation rises.. Low unemployment, faster wage growth, higher costs, higher inflation.
Sources
Last updated 8 November 2026. Spotted a mistake? Tell us.