In October 2018, St. Louis Fed President James Bullard claimed his organization had killed the work of ancient economist AW Phillips. It was the latter who has had his name, voluntary or not, attached to the eponymous curve at the center of this and seemingly every modern Economics mystery. And a big one was brewing in ’18.
The unemployment rate was falling and by official accounts the economy was doing better than well. Sliding those views into the Phillips Curve, policymakers at the Fed worried inflation was at risk of heating up. After all, at heart the curve posits a relationship between employment and price changes.
As employment rises, or unemployment falls, consumer prices should be moved higher. Intuitively, there seems to be some sense behind the method: companies are forced to compete for increasingly scarce workers, raising wages and pay, therefore immediately seeking to offset these higher costs increasing prices they charge consumers.
But in 2018, indeed every year since around 2014, it wasn’t working. To be fair, Economists realize there cannot be a linear relationship between work and prices, that there is likely some threshold beyond which triggers an acceleration to the underlying mechanics.
They call this maximum employment. In the wake of four (wasted) QEs starting off 2013, authorities at the Federal Reserve wondered aloud if they might’ve set a collision course with that line – this was the impetus to that whole “taper tantrum” misunderstanding (it was never a “tantrum”). According to the most up-to-date econometrics, maximum employment was somewhere around 5.5% to 6.0% unemployment.
After years of very little progress following the Great “Recession” (no one bothers to explain why), in 2013 the unemployment rate moved decisively lower and by 2014 was put within range of these estimates. Janet Yellen’s tenure at the Fed thus began with her constant references to “overheating”, unleashing an almost pathological impatience to terminate QE and go directly to rate hikes.
But the foretold inflation never made its appearance. Quite the contrary, actually, as instead the US economy very narrowly avoided a recession while the rest of the world was walloped by unforeseen and unexplained monetary madness (Euro$ #3).
Still, the unemployment rate continued downward anyway, plaguing econometric models and modelers alike. They simply adjusted their regressions out of expedience, time and again lowering the estimated threshold for full employment. First it was 5.5%. Then 5.2%. Maybe 5.0%. Or even 4.5%.
By 2018, models couldn’t get it any lower without risking exposing the sham (your models can only be broken if you have to input full employment at, say, 2% or even 1% unemployment just to match the data).
Always crafty if for the wrong reasons, officials went to work coming up with other explanations intent on preserving the models rather than legitimately explaining the evidence. According to President Bullard that October in 2018, the reason for the puzzle was that the Phillips Curve had been murdered. No, only credibility had been.
Appearing on NPR, Bullard only partly joked:
“If you put it in a murder mystery framework – ‘Who Killed The Phillips Curve?’ - it was the Fed that killed the Phillips curve.”
Again, like most things Economics, it sounded plausible at first, at least as a way to avoid implicating the unemployment rate. The reasons for doing so were, and are, obvious: a low unemployment rate that is in fact low and not artificial or misleading vindicates QE and the Fed. They could say their programs worked and do so very simply by pointing to max employment or better.
However, that could not have been true if Phillips’ curve was still alive, otherwise anyone who thought only a few seconds about it would’ve asked, as Yellen was often forced to, where’s the inflation? One or the other had to go and there was absolutely no way they were going to ditch the unemployment rate. That was QE’s saving grace.
As it would turn out, they didn’t want to entirely get rid of Phillips, either. But it would at least have to be massively reformed, reborn as the “flat” Phillips Curve.
You’ve seen the graphs of economics curves before, think supply and demand only this time it is a single one between unemployment and consumer prices. In the Flat Phillips model, the “curve” is no longer one of those, instead becoming a straight vertical line, or near enough to one.
What that says is no matter how low (or high) unemployment might go, it doesn’t translate into consumer prices like a normal Phillips Curve. The benefit of redrawing the line is obvious, explaining away the highly inconvenient, often embarrassing inflation puzzle.
Or did it?
On the surface, yes. It allowed people like Bullard and Jay Powell to truck around the media and say something smart about how QE was still effective because the unemployment rate still meant something while also “explaining” the lack of inflation Fed forecasters had constantly forecast prior to Flat Phillips.
However, if you ever sat and thought about it for more than a millisecond, you knew this was just nonsense; refusing to admit defeat on one or several parts of key Federal Reserve and Economists’ assumptions. Maybe the reason inflation never happened was instead due to a faulty unemployment rate (participation problem) which therefore also showed from the key labor perspective that QEs accomplished nothing.
The alternative we’re given, Flat Phillips, is pure nonsense. I’ll let James Bullard attempt to explain it to you:
“The Fed has been much more mindful about targeting inflation in the last 20 years. And because of that, we have lower inflation, more stable inflation. And so there isn't much of a relationship anymore between labor market performance and inflation.”
He’s basically saying, just accept our premise(s). If you don’t, you’re instead asked to believe that somehow businesses in the real world when faced with a scarcity of real workers (accurate unemployment rate) rather than compete and pay more to secure their employment, they instead say to themselves, you know what, we can’t raise wages because that will trigger inflation and we all know it will cause the Fed to raise rates until inflation disappears and that would be worse for all of us.
Do you hear how dumb this is? Even if it wasn’t completely batsh--, Occam’s Razor demands the other explanation anyway, the one which isn’t unnecessarily esoteric and shot through with unscientific psychobabble.
Yet, Flat Phillips remained the standard view which only set the stage for 2021. Why weren’t central banks worried about consumer prices even after several rounds of massive fiscal interference? Yep, Flat.
In other words, the models which had all been updated with this new approach even after generously upping all the multipliers from Fed and fed programs projecting a surging economy which would (could!) not produce inflation no matter how low the unemployment rate was forecast to go. A linear Phillips Curve says, again, there’s no longer any relationship or much of one.
Consumer prices then surged in particular after the third “helicopter” payment was made. Looking back on the period, many Economists today realize it was all a supply shock. Here’s where Ben Bernanke and Olivier Blanchard begin their explaining from just a few weeks ago:
“In contrast, some economists (including one of the authors) argued that wage inflation, and consequently price inflation, could rise much more than predicted by conventional calculations predicated on a flat Phillips curve (Summers, 2021; Blanchard, 2021). Their concerns were that the increase in aggregate demand likely to result from the unprecedentedly large fiscal transfers, together with the cumulative effects of the easing of monetary policy begun in March 2020, could cause more overheating of an already-tight labor market than the optimists expected.”
This was the Phillips-is-not-flat view. As it turned out, that one wasn’t the reason, either.
“The critics’ forecasts of higher inflation would prove to be correct—indeed, even too optimistic—but, in substantial part, the sources of the inflation would prove to be different from those they warned about... In retrospect, the failure to forecast the inflation burst reflected in large part the fact that, in focusing on the labor market, both the Fed and its critics underestimated the inflationary potential of developments in goods markets, that is, from increases in prices given wages.”
It wasn’t Phillips, labor, anything related, rather just a very simple and straightforward, non-psychology supply shock.
“We conclude that labor market tightness made at most a modest contribution to inflation early on, resolving the puzzle of how inflation could rise so much despite a flat wage Phillips curve. Instead, most of the early action in inflation came from the goods market, in the form of sharp increases in some relative prices, including commodity prices and prices in supply-constrained sectors.”
Good news, then, at least for “inflation” because the supply shock variety of consumer price acceleration reaches its own end on its own (very ugly) terms. Of course, this raises another question: why are central banks still raising rates and raising holy hell about how “inflation” continues to be the greatest threat to the world economy (*the Chinese strenuously object in word and by action).
You know the answer: the Phillips Curve. It will never go away because that’s all they have to build on.
The constant references every hiking central bank makes to “tight” labor markets betrays the thinking. There are still huge concerns about the wage-price spiral as if maybe Flat Phillips was somehow just a temporary phase. Others worry that low levels of unemployment together with stubborn core CPI measures could potentially de-anchor inflation expectations and reignite prices.
Officials now see that 2021 and early 2022 was a supply shock that got out of hand for non-economic, mostly political reasons (from pandemic politics to invasion). But now they worry that former “inflation” as it only slowly fades might breed then give over to a new type, one more familiar to the models than reality.
They may as well just change the name to Phillips Policy, but that, too, would be entirely too revealing.
The whole thing is pure theater, an unserious puppet show. Policymakers are simply making this all up as they go. The only real question is when the curtain finally comes down on it.
One final thought: notice what topic remains completely absent from the entire discussion – not just here, but all of it. Inflation is always and everywhere a monetary phenomenon, yet it is the one factor we can never bring up, the one topic never broached. The only time you even hear the term “monetary” is when it gets attached to central bank interest rate policy.
That, too, is a dodge, an intentional obfuscation; something you’re just not supposed to think about. What’s monetary about interest rates? I guess it's the same supernatural ability to dissuade corporate HR reps desperate for scarce workers from paying market rates for them.