Did Globalization Affect the Phillips Curve?

The Phillips Curve is the observed stable and inverse relationship between inflation and unemployment. When I took my economics courses, lo! those many years ago, it was taught as Holy Writ. It came into disrepute a decade or so ago when the relationship appeared to have broken down.

Now, impelled presumably by the higher rate of inflation, the discussion over the Phillips Curve has heated up. Is there a relationship between inflation and unemployment? A. W. Phillips, Paul Samuelson, and Milton Friedman all said “yes”. John Tamny says “no” in this piece at Forbes:

Back to reality, inflation has nothing to do with unemployment. Think about it. Consider Lebanon at present, Argentina for decades, and perhaps Mexico in decades past. Inflation is a decline in the unit of account. Put more plainly, inflation is a currency devaluation. More on actual inflation in a bit, but for now it’s useful to remind readers that a focus on unemployment when contemplating inflation is a sign of the mind wandering, or a thought non sequitur.

In a working paper at the National Bureau of Economic Research (PDF) David Ratner and Christopher Sims say that labor market policies resulting in less bargaining power for workers has “eroded” the validity of the Phillips Curve:

In particular, we build a theoretical model in which workers’ bargaining power determines the slope of the Phillips curve. We argue that the “missing inflation” puzzle is due to a collapse of workers’ bargaining power that has in turn left the slope of the Phillips curve nearly flat.

Figure 1 juxtaposes the work stoppage index for the United States (blue solid line, the left axis), one potential measure of workers’ bargaining power, and the core PCE price inflation rate (red dashed line, the right axis). The figure suggests that the bargaining power of workers may be an important driver of the inflation dynamics during 1960s and 1970s. Both the bargaining power of workers and the inflation rate suddenly collapsed around the mid-1980s. Correlation is, of course, not causation and another interpretation is possible: monetary policy tightening under Paul Volcker led to the disinflation shown in the figure, which in turn may have made striking for cost of living adjustment less urgent as the inflation rate has been stabilized.

Mario Seccareccia and Guillermo Matamoros Romero expand on that in a piece at the Institute for New Economic Thinking:

The US Fed as well as many other central banks internationally seem now to be united in favor of a steep hike in the Fed’s policy rate, as we witnessed with the most recent 0.75 percent jump on June 15. We are told, moreover, that there are many more increases to come since the Fed rate is, supposedly, still much below its “neutral” level. For a very recent plea in support of what may have been the “mother” of rate hikes in the United States, namely another “Volcker shock”, one has only to peruse the recent paper by Bolhuis, Cramer and Summers (2022) in which they suggest that, to get the current inflation rate down to align with the US Fed’s 2 percent inflation target, it would now “require nearly the same amount of disinflation as achieved under Chairman Volcker.” (2022, p. 1).

Given the nature of the current supply shocks affecting our weak Covid-battered economies, orchestrating another Volcker-style scenario by creating yet another deep recession is chilling. Besides, it would appear to be somewhat in conflict with the above assessment of former US Fed Chair Janet Yellen in 2019 as well as with the research of these two US Fed economists, Ratner and Sim, who suggest that the slope of the Phillips Curve is actually relatively flat and it has remained so for decades, for reasons that have little to do directly with the Volcker shock of the early 1980s.

I have only a few observations to add to the pieces linked. First, the Phillips Curve has always been primarily an empirical observation rather than a philosophical assertion. The statistical evidence is quite strong or, at least, it was until a decade or so ago.

Second, note that no one explains what is meant by a “loss of worker bargaining power”. It can have all sorts of causes including importing workers (legal or illegal) rapidly, overseas competition, workers without the training or experience desired, labor unions with goals that take priority over the things measured by Mssrs. Ratner and Sims which they use as a proxy for a loss of bargaining power, or workers that don’t have the skills, training, or experience that employers want.

Finally, none of the writers seems to understand the U. S. law that requires the Federal Reserve to underwrite Treasury Department debt. We don’t devalue our currency or, at least, such events are rare. The Congress appropriates money. If tax revenues are insufficient to cover the amounts appropriated the Treasury borrows. Period. Of which parts of that process does Mr. Tamny disapprove?

I presume it’s the appropriations. Would raising taxes to cover the appropriations cause fewer people to lose their jobs than raising interest rates? Note, too, that those injured by high interest rates are generally the same as those harmed by decreasing employment. It’s a judgment call and under present circumstances it looks to me as though decreasing employment is a risk less than that of increased inflation.

Please keep in mind that I would prefer that we had neither. I would also prefer that American workers had less competition from workers overseas or from rising numbers of imported workers. But as somebody or other said you can’t always get what you want. I almost never can. Didn’t the same guys write a song about that, too?