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.
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
