The Phillips Curve, an economic model developed by A. W. Phillips purports that inflation and unemployment have a stable and inverse relationship.
This has been a fundamental guiding economic theory used by the Fed for decades to set interest rates.
A new Fed Study shows the Phillips Curve Doesn’t Work.
A fundamental relationship of mainstream economic theory at the heart of the Federal Reserve’s strategy for setting interest rates has been a poor guide for policy makers for at least three decades, according to a study by the Philadelphia Fed’s top-ranking economist.
The paper, co-authored by Philadelphia Fed Director of Research Michael Dotsey, shows that forecasting models based on the so-called Phillips curve, which asserts a link between unemployment and inflation, don’t actually help predict inflation.
“Our results indicate that monetary policymakers should at best be very cautious in their reliance on the Phillips curve when gauging inflationary pressures,” Dotsey and Philadelphia Fed economists Shigeru Fujita and Tom Stark wrote.
Their study is timely. Fed officials have been surprised by a deceleration in U.S. inflation over the past several months despite a continued decline in unemployment, the opposite of what the Phillips curve relationship would predict.
The Philadelphia Fed economists found that rising unemployment was sometimes able to help predict lower inflation, but falling unemployment didn’t help predict higher inflation. They noted that was particularly the case during the 1970s and early 1980s when the Fed responded to runaway inflation by raising rates so high that the U.S. economy fell into recession.
“Our evidence may indicate that using the Phillips curve may add value to the monetary policy process during downturns, but the evidence is far from conclusive,” they wrote. “We find no evidence for relying on the Phillips curve during normal times, such as those currently facing the U.S. economy.”
Admitting the Obvious
That report is not surprising at all other than a Fed researcher would finally admit the obvious.
However, the FOMC members will keep using the model, despite the study, and despite the obvious.
Absurd Inflation Discussion
A few days ago, in response to Absurd Inflation Discussion by Fed Jackasses, Pater Tenebrarum at the Acting Man blog pinged me with this comment:
“It is de facto not possible to measure price inflation or a general level of prices. The latter is simply nonsense, it doesn’t exist. Both money and goods are subject to changes in supply and demand, hence there is no yardstick by which the purchasing power of money could be measured. And this is before we get to the fact that adding up and averaging the prices of disparate goods simply makes no logical sense.”
So, not only is the Phillips Curve useless at predicting inflation, one cannot properly measure inflation in the first place.
None of the models the Fed relies on works. Repetitive bubbles are proof enough.
Unemployment vs CPI
Pater Tenebrarum at the Acting Man Blog emailed this chart.
Back in March, Janet Yellen commented: “The Phillips Curve is Alive“.
An Acting Man article by MN Gordon entitled Why Janet Yellen is Toast blasted that bit of nonsense.
Since Phillips first derived the Phillips Curve there have been lengthy episodes that are inconsistent with his original findings. Particularly, the late 1970s – when inflation and unemployment went vertical in tandem.
How could it be that both went up at once? Weren’t they mutually exclusive? According to the Phillips Curve this was impossible. Yet it happened all the same. In short, the Phillips Curve is a BS theory.
The fact that Yellen still spews this nonsense is intolerable and insulting. This, among other reasons, is why she is toast. Her four-year appointment is set to end in February 2018. We suspect she won’t make it much past the next Presidential inauguration.
Brandolini’s Law
It’s not just the Phillips Curve either. Keynes thought inflation and recession could not happen at the same time. Yet, people still cling to that too. This leads to:
Creative Nonsense
Those hoping to solve the inflation puzzle can do so here: Central Banks Puzzled as Global Inflation Hits Lowest Level Since 2009: Solving the Puzzle.
Also consider “Oh That Elusive” Inflation!
Those seeking to mock Cleveland Fed creative nonsense may wish to consider: “Idiosyncratic and Transitory Factors” Holding Down Inflation: New Definition of Transitory
As protection against Fed policies, it’s wise to own some gold. In case you missed it, please consider How Much Gold Should the Common Man Own?
Mike “Mish” Shedlock
Mish, Am I missing something? I thought the stagflation of the 1970’s disproved the Phillips curve years ago. Did someone breathe new life into it?
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Yes it should have
And it should have killed Keynesianism too.
Keynes thought inflation and recession together were impossible
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I just googled something. sounds like some geniuses decided stagflation just shifts it, or as i call it a fudge factor
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Keynesian macroeconomics is essentially a Cargo Cult, similar to Freudian analysis….
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Yes, I thought Friedman showed that the Phillips Curve was a vertical line, way back in the 70s. I didn’t know anyone still believed in it.
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I just added to my post
Back in March Janet Yellen said “the Phillips Curve is alive”
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Appreciate your comments on Trump flip flops … but he’s not the only one.
Yellen
June:
She also made a bold prediction: that another financial crisis the likes of the one that exploded in 2008 was not likely “in our lifetime.”
https://www.cnbc.com/2017/06/27/yellen-banks-very-much-stronger-another-financial-crisis-not-likely-in-our-lifetime.html
last week:
“We can never be sure that new crises will not occur”
https://www.federalreserve.gov/newsevents/speech/yellen20170825a.htm
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Stagflation in the 70s, was once taken as confirmation of Friedman’s and Phelps’ critique of the Philips curve. Both critiques basically states that, in at least anything but the shortest run, inflation expectations of labor market participants catch up with inflation, such that the level of inflation quickly becomes completely irrelevant for determining employment/unemployment rates. That’s where Friedman’s famous “Inflation is always and everywhere a monetary phenomenon.” one liner comes from.
Progressives being progressives, and Keynesians being a subset of them, of course, as usual, believe thiiiingz aaaare diiiiiferent thiiiiiiiiz tiiime. Such that once inflation expectations were once again well anchored following the Volcker recession, they soon figured they could start playing Phillips Curve like games with inflation again. Thinking the hard won learnings from the past, didn’t apply to them thiiiiiz tiiiiiiime, either… And of course, just as always, progressives are wrong. About absolutely everything. They wouldn’t be progressives if they weren’t…
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“The Philadelphia Fed economists found that rising unemployment was sometimes able to help predict lower inflation”
From an off the cuff reading of that chart all I see is that high inflation causes unemployment, and that more recently high unemployment has not led to lower inflation nor was stimulated by it, which basically tells me that the previous low inflation was in fact a saturation of price inflation / what would have normally been deflation, the lack of deflation after rise in unemployment is just symptomatic of monetary/legislative support and a “managed” economy.
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Maybe the fact that the very definition of “unemployment” has changed so dramatically over the past several decades is what has ruined the accuracy of the Phillips Curve.
Garbage in, garbage out, as they say.
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The chart shows the business cycle. Inflation rises due to resource constraints, demand gets hurt, and unemployment rises. Inflation falls, people start buying again, unemployment falls.
It stops during the current Great Recession. Which, I believe, is because the Great Recession is a once in a 100 years financial depression, not a normal business cycle recession. But, hey, I’m just a computer science major, not a master of the universe economics major.
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Great recession is maybe part of a 100yr financial depression, i.e. started in the 70’s and ongoing. That depression is not charted or understood as such, but if you look at the commencement of heavy financialisation as the start of a depression in monetary value/meaning in the real world, then we still have a way to go to reach Japan, and then some, unless it all goes Venezuela yahoo.
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From the early 80’s they had managed to iron out the inflation, so the unemployment is just a social/legislative/management issue, and is disconnected now.
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The Unemployment Rate is useless without factoring in the participation rate.
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Tony, you & Mish need to come up with a formula that will combine participation with unemployment for chartable results. It will be interesting to see how that compares with actual economic conditions.
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IMO, the participation rate is the unemployment rate. It doesn’t matter why people aren’t working. Only that they are.
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It looks more like unemployment lags inflation by 2 to 3 years. This does not indicate an inverse relationship, except on the coincidence that the inflation cycle is twice the lag. Whether this pattern resumes is anybody’s guess.
If you want to be great, don’t inflate!
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The retail story of the day. Best Buy down almost 12% after reporting a good quarter.
A culprit?
Hhmm …
(Reuters) – Best Buy Co Inc (BBY.N) reported another strong quarter of same-store sales on Tuesday, but shares of the No.1 U.S. consumer electronics retailer fell after it cautioned that the performance should not be seen as a “new normal.”
…
Best Buy has tried to turn itself around by closing underperforming stores, improving customer service and most importantly, matching Amazon.com Inc’s (AMZN.O) low prices.
https://www.reuters.com/article/us-best-buy-results-idUSKCN1B917S
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BBY should benefit from Sears going bankrupt. I think they’ll survive. They sell a lot of large big ticket items and many don’t feel comfortable buying such things on-line.
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it works. what the inventor (& the Fed) didn’t know: its a lagged indicator. Ah, Time, you bothersome detail!
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Congress tasks the Fed to control inflation and deflation that cannot be defined, cannot be measured, and can only be exacerbated by monetary policy. Par. How about the employment mandate?
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The curve isn’t useless, it can be used as a bad example.
(As a similar proverb states)
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The automation and robotics steamroller is going to obsolete a lot of economic theory. Increasing permanent un/underemployment is going to throw a wrench into old assumptions and calculations.
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I actually agree with Joe this time, but it’s that there Brandolini feller that’s really onto something big I think.
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Automation has been going on for decades. Cars have been built by robots for decades now. Food processing is almost entirely automated. Today is no different than the past.
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A riddle that can’t be solved by an economist. The solution lies outside the core competencies of their knowledge.
As for CPI. Agree with Pater 100% that it can’t be measured, but vehemently disagree that the metric attempted to measure it is completely worthless, but that’s an argument that gets into things like the laws of big numbers and averaging out errors over time.
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Weren’t you working on a book related to this?
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I was actually having parts edited, and being a rather poor and totally inexperienced writer, combined with my personal anal retentive focus on minutiae, I was getting a bit overwhelmed by it, so I gave myself six months off, which funny enough ends this week. I’ll knock out as much as I can between now and end of year, and then take some more time off to travel (aka -ski), after which I should finish it. Then I will never have the idiotic idea to ever write anything ever again 🙂
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Since this is a conclusion by the top Fed economist it must be true, who could argue. Who else but an ivory tower PhD elitist economist with no real work experience and no clue what it means to run a business could come up with that conclusion. Don’t bother checking how things are going in the real world. I guess all the business’ who have out help wanted signs and cant find employees, having to raise their wages and subsequently their prices, have absolutely no effect on inflation. Perfect eg is construction costs. This is pervasive throughout the business landscape. What utter bullshit
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The correlation between unemployment and credit (time slope of private debt) is north of 90% according to Steve Keen. The correlation between CPI and credit is very weak because CPI does not include asset prices like house prices and stock prices. At minimum suggest one use corrected CPI including financial asset prices. This data would be interesting plotted against unemployment. Per Keen aggregate demand for goods, services, and financial assets should scale on credit plus GDP.
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What all this really means is that there shouldn’t be a Fed, nor should government be making economic policy other than to protect people’s liberty and property rights.
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“See, the Phillips Curve takes its name from a 1958 Economica paper by A.W. Phillips, which studied the relationship between unemployment and wage inflation in Britain, using a century of historical data through the 1950’s. What Phillips found was this: when unemployment was low, wage inflation tended to be above-average, and when unemployment was high, wage inflation tended to be subdued.”
https://www.hussmanfunds.com/wmc/wmc110404.htm
The curve can only be used for real wage inflation, not general inflation! Applied only to real wages it’s common sense, applied to general prices it’s deranged. Between this and cash on the sidelines there should be a required Hussman economic myths debunked class required for an economics degree.
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I don’t think the feds really put much credence in these models. They use them to support a
hidden agenda or obfuscate the truth . Do you really think Janet would say “oh we have to keep interest rates low so that the government can fund it’s massive deficits? “. Or” we have tried 8 years of accommodative monetary policy and we have had no growth .”
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Most economic theory is sound. At least in theory. The problem is the worlds governments don’t let the economy settle into an equilibrium. They constantly distort the economy in unnatural ways.
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The Phillips curve was a valid tool until the early 1980s when the destruction of collective bargaining by weaponising unemployment became the central policy objective of the UK Conservatives.
A recent paper by the Bank of England’s Chief Economist, Andy Haldane, observes that current data mirrors the pre-industrial revolution relationship between inflation and unemployment.
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