A model economy in flowing water.
Julian Frost for Planet Money: A Guide To The Economic Forces That Shape Your Life / NPR / W. W. Norton
Just for you newsletter readers, we wanted to share a favorite, short excerpt from our book, Planet Money: A Guide to the Economic Forces That Shape Your Life, by Alex Mayyasi, available in book stores starting today!
Bill Phillips — the creator of the so-called “Phillips Curve,” which remains central to economic discussion — took a creative approach to studying the economy.
Born in New Zealand, Phillips tried hunting crocodiles, mining gold, and worked as an electrical engineer before studying economics in London after World War II. In 1949 he built a Rube Goldberg–like contraption in his garage: tubs and chambers through which water flowed back and forth. He called it a model of the British economy.
At the London School of Economics (LSE) he demonstrated the machine. As his friend Richard Lipsey recalls, “all the staff came out to humiliate this upstart idiot.” Phillips showed water moving from a Treasury tank into chambers labeled health and education as government spending, then pumping back to the Treasury at rates adjusted by a lever representing taxation. After ten minutes, Lipsey says, the critics were silenced and the LSE offered Phillips a job.
Phillips began mixing with economists debating macroeconomics — the study of growth and productivity at the national level. He aimed to make market economies less chaotic. Economic history is marked by booms and busts: crashes and panics recurring over decades. Economists call that pattern the business cycle. After the Great Depression, John Maynard Keynes argued governments could moderate these cycles by adjusting spending: restrain spending when the economy overheats, and boost it during downturns.
Phillips and his peers also thought inflation mattered, since it linked to unemployment. With low unemployment, workers can demand higher wages; higher wages can raise prices, producing inflation — a wage-price spiral. Phillips was offered a dataset: 100 years of UK wage and unemployment numbers. He plotted the data and, on Monday, returned with a graph that stunned his colleagues. It showed an inverse relationship between unemployment and wage-rate growth, implying a trade-off between employment and inflation: low unemployment accompanied higher inflation.
The graph spread. Economists found similar relationships in other countries, including the United States. In 1961 Paul Samuelson and Robert Solow named it the Phillips Curve, and Samuelson included it in his Economics textbook. Policymakers and White House advisers used the Phillips Curve to describe the employment–inflation trade-off. Central bankers — the Bank of England, the Federal Reserve — relied on it as a guide for managing inflation.
When Phillips made his graph, central bankers still had a limited grasp of inflation’s mechanics. The era of fiat currency — money not backed by gold but by trust that governments would manage the money supply responsibly — was relatively new after the gold-standard disruptions of the 1930s. The Phillips Curve served as a kind of manual for inflation management up through the 1960s. But in the 1970s the American economy began behaving differently, forcing economists to revise the playbook. That story is another chapter.
Today’s newsletter is excerpted from Chapter 18 of our book, Planet Money: A Guide to the Economic Forces That Shape Your Life. (If you spot it in a bookstore, let us know what section it is in.)
The original Phillips Curve
Julian Frost for Planet Money: A Guide to the Economic Forces That Shape Your Life / NPR / W. W. Norton