In general, economists have observed an inverse relationship between the unemployment rate and the inflation rate, i.e., the rate at which prices rise. Alternatively, when the unemployment rate rises above the natural rate, inflation will tend to decelerate. Economist A. W. Phillips found that between 1861 and 1957, there was a negative relationship between the unemployment rate and the rate of change in wages in the United Kingdom, showing wages tended to grow faster when the unemployment rate was lower, and vice versa. The natural rate model suggests that there is a certain level of unemployment that is consistent with a stable inflation rate, known as the natural rate of unemployment. When the unemployment rate falls below the natural rate of unemployment, referred to as a negative unemployment gap, the inflation rate is expected to accelerate. Within the natural rate model, the natural rate of unemployment is the level of unemployment consistent with actual output equaling potential output, and therefore stable inflation. However, as wages increase, upward pressure is placed on the price of all goods and services because labor costs make up a large portion of the total cost of goods and services. Over time, the average price of goods and services rises to reflect the increased cost of wages. Productivity growth, and 4. As the characteristics of the labor force change—for example, with respect to age, educational attainment, and work experience—and alter the productive capacity of the economy, the natural rate is also expected to shift. An increase in the expected rate of inflation will be translated into an actual increase in the rate of inflation as wages and prices are set by individuals within the economy. Economic events that impact the supply of goods or services within the economy, known as supply shocks, can also impact the rate of inflation. This leads to a spike in the overall price level in the economy, namely, inflation. As a result of the global financial crisis and the U.S. 2007-2009 recession, the unemployment rate rose above 10% and remained significantly elevated compared with estimates of the natural rate of unemployment for multiple years, as shown in Figure 1 . Numerous competing hypotheses exist for why a significant decrease in the inflation rate failed to materialize. Limited empirical work has found evidence of this behavior by businesses during the 2007-2009 recession, and therefore may help to explain the unexpectedly modest decrease in inflation following the recession. Increased Inflation Anchoring

Changes in how individuals form inflation expectations, as a result of broad changes in how the Federal Reserve conducts monetary policy, may also help to explain the unexpectedly moderate decrease in the rate of inflation after the 2007-2009 recession. This change in how economic actors formed inflation expectations is thought to have reduced the volatility of changes in the rate of inflation during economic shocks. Results of this research suggest that when considering the effects of monetary or fiscal policy on inflation, policymakers would benefit from using a measure of the unemployment gap that weights the unemployment rate for the short-term unemployed more heavily than the long-term unemployed. According to the natural rate model, if government attempts to maintain an unemployment rate below the natural rate of unemployment, inflation will increase and continuously rise until unemployment returns to its natural rate. As discussed in the " Time Varying Natural Rate of Unemployment " section, four main factors determine the natural rate of unemployment, (1) the makeup of the labor force, (2) labor market institutions and public policy, (3) growth in productivity, and (4) contemporaneous and previous levels of long-term unemployment.
The unemployment rate is a vital measure of economic performance. A falling unemployment rate generally occurs alongside rising gross domestic product (GDP), higher wages, and higher industrial production. The government can generally achieve a lower unemployment rate using expansionary fiscal or monetary policy, so it might be assumed that policymakers would consistently target a lower unemployment rate using these policies. Part of the reason policymakers do not revolves around the relationship between the unemployment rate and the inflation rate.
In general, economists have found that when the unemployment rate drops below a certain level, referred to as the natural rate, the inflation rate will tend to increase and continue to rise until the unemployment rate returns to its natural rate. Alternatively, when the unemployment rate rises above the natural rate, the inflation rate will tend to decelerate. The natural rate of unemployment is the level of unemployment consistent with sustainable economic growth. An unemployment rate below the natural rate suggests that the economy is growing faster than its maximum sustainable rate, which places upward pressure on wages and prices in general leading to increased inflation. The opposite is true if the unemployment rate rises above the natural rate, downward pressure is placed on wages and prices in general leading to decreased inflation. Wages make up a significant portion of the costs of goods and services, therefore upward or downward pressure on wages pushes average prices in the same direction.
Two other sources of variation in the rate of inflation are inflation expectations and unexpected changes in the supply of goods and services. Inflation expectations play a significant role in the actual level of inflation, because individuals incorporate their inflation expectations when making price-setting decisions or when bargaining for wages. A change in the availability of goods and services used as inputs in the production process (e.g., oil) generally impacts the final price of goods and services in the economy, and therefore changing the rate of inflation.
The natural rate of unemployment is not immutable and fluctuates alongside changes within the economy. For example, the natural rate of unemployment is affected by
changes in the demographics, educational attainment, and work experience of the labor force; institutions (e.g., apprenticeship programs) and public policies (e.g., unemployment insurance); changes in productivity growth; and contemporaneous and previous level of long-term unemployment.
Following the 2007-2009 recession, the actual unemployment rate remained significantly elevated compared with estimates of the natural rate of unemployment for multiple years. However, the average inflation rate decreased by less than one percentage point during this period despite predictions of negative inflation rates based on the natural rate model. Likewise, inflation has recently shown no sign of accelerating as unemployment has approached the natural rate. Some economists have used this as evidence to abandon the concept of a natural rate of unemployment in favor of other alternative indicators to explain fluctuations in inflation.
Some researchers have largely upheld the natural rate model while looking at broader changes in the economy and the specific consequences of the 2007-2009 recession to explain the modest decrease in inflation after the recession. One potential explanation involves the limited supply of financing available to businesses after the breakdown of the financial sector. Another explanation cites changes in how inflation expectations are formed following changes in how the Federal Reserve responds to economic shocks and the establishment of an unofficial inflation target. Others researchers have cited the unprecedented increase in long-term unemployment that followed the recession, which significantly decreased bargaining power among workers.