Foolish Financial Framing: The Phillips Curve Remains Despite Fed Claims
The director of the Federal Reserve has made somewhat of a mockery of economic theory.
Recently, testifying before the Senate Banking Committee, Jerome Powell, chairman of the US Federal Reserve, went on record as saying that “The relationship between the slack in the economy or unemployment and inflation was a strong one 50 years ago ... and has gone away,”
Following this, he would later add “In additional to that, we are learning that the neutral interest rate is lower than we had thought and ... the natural rate of unemployment rate is lower than we thought. So monetary policy hasn’t been as accommodative as we had thought,” at least, according to CNN.
In reading this, I must question the very nature of the statement. For the head of the Federal Reserve to imply that the relationship of the Philips Curve has simply vanished seems incredibly foolhardy. For those unaware, the Phillips curve measures the relationship between unemployment and inflation, wherein as employment increases, so to does inflation over time, as increasing employment leads to less available labor, which raises wages, which raises prices due to the supply shortfall that comes from having an increased demand on the market.
Of course, Powell would later clarify “At the end of the day, there has to be a connection because low employment will drive wages up and ultimately higher wages will drive inflation, but we haven’t reached that point. In many cases, that connection between the two is quite small these days,”
Again, I question the nature of this statement.
What framing is Mr. Powell speaking from, exactly? Does the head of the Fed intend to suggest that the very nature of the Phillips curve has shrunk in impact? Because I would posit instead that there are a multitude of things causing this shift that have little, if anything to do with the fundamental relationship between the employment and inflation.
There are many factors that have gone into the current situation we’re in, which Mr. Powell fails to recognize. Union busting, market globalization, and an average wage that has not risen to keep pace with increases in CPI all factor into the current inflationary debt that America is fighting its way back from. For almost thirty years now, inflation has stayed within the range of 0.1% to a peak of 6.1% in 1990, and yet wages have seen little average increase. Only in some cities has a guaranteed minimum wage hike truly started to push back on the wage debt owed and incurred by years of relatively low inflation and relatively steady GDP growth, which will almost assuredly have knock-on effects to the economy because of it.
The model of the Phillips curve is a simplified one that does not take these many factors into account when dealing with multiple systems of varying scales.
This does not mean that the fundamental relationship between unemployment and inflation has changed, rather merely that measuring unemployment nationally while trading and doing so much international business will not provide for an accurate model, especially when outsourcing labor is as easy as it has ever been.
The game of wage growth is a difficult one to speculate over, admittedly, as it requires a great deal of guesswork regarding individuals and their personal choices, but to fundamentally disregard one of the underpinning laws of Economics that has informed monetary policy for over a century now is dangerous, especially for someone who is in direct control of the institute charged with printing money on behalf of the US Government.
If we act as though this relationship does not exist without attempting to understand the reasons and factors that have changed the relationships of the markets we find ourselves discussing, we may take disastrous steps that undermine the very function of those markets out of ignorance or else self-assured stupidity.
In that light, I very much must question why the chairman of the Federal Reserve would frame this discussion in this light, as though he has no understanding of what factors possibly have brought about this change. Perhaps this is merely poor reporting on the part of CNN, but even that, I think, would not explain someone downplaying this fundamental tie between employment and wages.