The Phillips Curve: Dead or Buried Alive? 

Former Federal Reserve Chair Ben Bernanke is the latest in a string of economists to bid the longstanding macroeconomic principle farewell.

On January 4, 2019, three of the most important economic figures in the United States today — Former Fed chairs Ben Bernanke and Janet Yellen, along with the current Fed chair, Jay Powell — convened for a panel at an economic conference in Atlanta, Georgia. Here, the topic of conversation revolved around the U.S.’s current economic boom, with unemployment under 4% and jobs growing at a steady rate. While this may sound like good news, for many economists, this is reason to worry — due to a phenomenon called the Phillips Curve, low unemployment is typically coupled with high inflation, since companies are forced to raise wages in order to attract workers and prices in order to maintain profits. Proponents of this theory point to the 1970s in America, a period of time in which prices were rising uncontrollably. In order to halt runaway inflation, then-chairman of the Federal Reserve, Paul Volcker, raised interest rates to 20% (which, by comparison, is 10x higher than it is today, at 2%). This move effectively killed the economy, pushing unemployment to 10%, but stopped inflation in its tracks [1].

If today’s economic boom will turn into tomorrow’s inflation nightmare, then the Fed will have to raise interest rates now in order to combat the problem. But current Federal Reserve chair Jerome Powell isn’t worried, and isn’t raising rates. He stated, “For me, at this time, [low unemployment] does not raise concerns about too high inflation.” When the three were subsequently asked if the Phillips Curve was dead, Dr. Bernanke shot back, “To use a slang – economic jargon, this is an endogenous phenomenon.” Those two words — ‘endogenous phenomenon’ — symbolize one of the biggest breakups in economic history: a decoupling of the Phillips Curve. In his brief remark, Dr. Bernanke was essentially stating that unemployment and inflation no longer have an observable relationship [1].

What made Dr. Bernanke say this? The logic behind his statement is simple — in the wake of the aforementioned crisis of the 1970s, people and companies alike realized that the Federal Reserve would raise interest rates to astronomical levels if it meant keeping inflation in check. Since then, this realization has provided an incentive to keep inflation low — and it has. In other words, the Fed killed the Phillips Curve [1].

Dr. Bernanke: Coroner, not Killer

While what Dr. Bernanke proclaimed was certainly controversial, it was nothing new. The former Federal Reserve chair was simply confirming what many lesser-known economists had been proclaiming for years. This present-day ‘miracle economy’ in the U.S. has many economists scratching their heads, not just Dr. Bernanke — while wages have increased for the most part, inflation has kept steady [2]. For example, economist Larry Summers of Harvard University argued that the Phillips Curve had “broken down,” citing the fact that, since 2010, the unemployment rate has fallen steadily from 10% to 4.4%, yet inflation has hovered between 1% and 2% [2]. In May 2018, Princeton economist and former Vice-Chairman of the Fed Alan Binder came to the same conclusion in his article “Is the Phillips Curve Dead?” for The Wall Street Journal, noting that “the correlation between unemployment and changes in inflation is nearly zero… Inflation has barely moved as unemployment rose and fell,” [3].

While Dr. Bernanke’s explanation for the Phillips Curve’s demise is inextricably linked to the history of the U.S., other economists have noted that the curve still does not hold up internationally. For example, Wall Street Journal columnist Greg Ip wrote, “[…] the Phillips Curve, has looked sickly for years. In Japan, it may be dead.” He backed up this claim by siting Japan’s low unemployment, at 2.5%, yet low inflation, at 1.1% for the entirety of goods and only 0.4% without energy and food (otherwise known as ‘core inflation’). In Singapore as well, the unemployment rate is 2.0% yet inflation is a mere 0.2% [3].

Too Early a Farewell?

Dr. Bernanke’s counterpart, Janet Yellen, has in the past disagreed with his theory. In 2015 and 2017, she pronounced that the Phillips Curve has successfully captured longer term movements in inflation since the Great Recession in 2007, although the short-run effectiveness of the Phillips Curve has diminished over time. Diminished, here, is a key word — Dr. Yellen has argued that the Phillips curve has flattened over time, so the low inflation readings of recent years are not symbolic of the curve’s demise, but rather a predictable outcome of a weakening, but still living, relationship [5]. Former Fed economist Ann Owen has a different approach, believing that the Phillips curve is merely resting. While unemployment has certainly shot down, wage growth has been relatively slow, and this is the key in explaining why inflation hasn’t budged a bit [7].

In 2010, James Stock and Mark Watson, economists from Harvard University, successfully solved the puzzle of why the rapid growth of unemployment post-2008 was not coupled with large-scale deflation. They did so by converting the relationship of the Phillips Curve. While before the model represented the interaction between the inflation and unemployment rates, they claimed that now it represented the relationship between the inflation rate and the change in the unemployment rate. Their theory essentially claimed that the Phillips Curve, post Great Recession, transformed from a level change relationship to rate of change effects. Their method has successfully explained away the lack of deflation after 2008. Yet, if it holds true for scenarios outside of the post Recession era, a new question is raised: what caused the Phillips Curve’s relationship to shift [6]? Could it be related to the post-1970s phenomenon that Dr. Bernanke claims broke the Phillips Curve, all those years ago?

Consequences for the Future

This unease surrounding the true nature of the Phillips Curve has led the current chairman of the Federal Reserve, Jerome Powell, to a treacherous crossroads. In light of the stellar performance of the U.S. stock market over the past year, President Trump has put pressure on Mr. Powell to maintain low interest rates, in order to spur on investment. Economists that believe in the Phillips Curve, however, see this as a grave mistake — keeping interest rates steady will only aid the explosion of inflation that is to come. Chairman Powell has reacted by taking a middle road — raising interests in slow, small increments [7]. But this is a solution that can only last for so long. If the Phillips Curve is truly dead, the Federal Reserve’s “standard models of the economy,” like those of the Congressional Budget Office, have no other inflationary model to replace it with. They have no other means to track the relationship between inflation and unemployment, and thus remain critically dependent on the Phillips Curve [3].

Whether or not the Phillips Curve is dead or dormant remains dubious. However, what is clear is that the Phillips Curve cannot exist for long in this grey zone. With the continued integration of global economies and labor markets, an accurate predictor of inflationary tendencies will be critical for the success of central banks’ policies in the years to come.

[1] Garcia, Cardiff and Vanek Smith, Stacey. “Why A Stellar Unemployment Report Isn’t Always A Good Thing.” NPR, National Public Radio, 11 Jan. 2019, 2019/01/11/684346418/why-a-stellar-unemployment-report-isnt-always-a-good-thing.

[2] “The Phillips Curve May Be Broken for Good.” The Economist, The Economist Newspaper, 1 Nov. 2017, for-good.

[3] Reynolds, Alan. “The Phillips Curve Is Dead (except in Federal Reserve and CBO Models).” Cato Institute, The Cato Institute, 24 May 2018, federal-reserve-cbo-models.
[4] Long, Heather. “This Is Almost the ‘Too Good to Be True’ Economy, Fed Chair Says.” The Washington Post, WP Company, 2 Oct. 2018, this-is-almost-too-good-be-true-economy-fed-chair-says/?utm_term=.53bb4e800d83.

[5] Murphy, Anthony. The Death of the Phillips Curve? . Federal Reserve Bank of Dallas, 2018, pp. 1–9, The Death of the Phillips Curve? .
[6] Gordon, Robert J. The Phillips Curve is Alive and Well: Inflation and the NAIRU During the Slow Recovery. National Bureau of Economic Research, 2013, pp. 1–54, The Phillips Curve is Alive and Well: Inflation and the NAIRU During the Slow Recovery.

[7] Ydstie, John. “Is It Time For The Fed To Say Goodbye To The Phillips Curve Theory?” NPR, National Public Radio, 29 Oct. 2018, to-say-goodbye-to-the-phillips-curve-theory.

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