The Impact of a Legendary Economics Curve

If you want to sound like an economist, just cite the Phillips Curve. Displaying the inverse relationship between unemployment and inflation, the Phillips Curve tells us that when one goes up the other goes down.

Phillips Curve

Where are we gong? To whether the Fed believes in the Phillips Curve.

Bill Phillips, the Moniac and the Curve

Dr. Phillips and the Moniac

Alban William Housego (Bill) Phillips was not your typical economist. After growing up on a New Zealand dairy farm and apprenticing at a hydroelectric station because he couldn’t afford college, he traveled to England via Australia, China, Russia and Japan. Along the way he hunted crocodiles, worked in a gold mine, learned differential equations through a correspondence course and was detained by the Japanese who thought he was a spy. However, he made it to London and by 1940 had his economics degree from the London School of Economics (LSE). During the war, while serving in the Royal Air Force Volunteer Reserve he was captured near Java. As a POW for three and one half years, he secretly built and operated miniature radios.

Bill Phillips

From: Wikipedia

After the war Bill Phillips began his academic ascent at LSE but reputedly was most interested in building a hydraulic model of the economy called Moniac during his spare time. The model’s amazing (!) water flows are worth seeing for four minutes or so in the following video:

https://www.youtube.com/watch?v=FeFwyWcIHts

The Curve

We have to fast forward to 1958 for the publication of the original Phillips Curves. Below you can see its initial form in “The Relation Between Unemployment and the Rate of Change of Money Wage Rates in the United Kingdom,1861-1957:”

From: “The Phillips Curve: A Rushed Job?”

Our Bottom Line: The Phillips Curve Debate

In the following Phillips Curve, assume you are at Point A and want to lower your unemployment rate. Using monetary policy, you should be able to decrease interest rates, increase economic activity, and thereby move to Point B.

Yes? Maybe.

The reaction to the Phillips Curve is varied. Agreeing with its basic premise, some economists say its accuracy just depends on the yardstick we use to measure inflation. At the other extreme, classical economists believe the curve displays a tradeoff that does not exist. And a third group suggests the curve is irrelevant right now because we have low unemployment and low inflation. And yes, we do have a fourth group that says, “Just wait, inflation will come.”

But what about Janet Yellen?

In a September 24, 2015 speech, she refers to an expectations-augmented Phillips Curve and then says that our inflation expectations are “well-anchored.”  She then continues, “The fact that these survey measures appear to have remained anchored at about the same levels that prevailed prior to the recession suggests that, once the economy has returned to full employment (and absent any other shocks), core inflation should return to its pre-recession average level of about 2 percent.”

Providing an affirmation of monetary easing, it appears that her Phillips Curve is somewhat horizontal.