When I took economics classes lo! those many years ago, the Phillips Curve, the relationship between inflation and unemployment proposed by New Zealand economist A. W. Phillips based on his study of about 90 years of British history, was taught as gospel. It was considered a force of nature, as sure as gravity.
Like all economic laws, it was a rule of thumb and like all rules of thumb it holds true until it doesn’t. The Phillips Curve began to break down somewhat after I left school and for the last 25 years it’s been on life support. As Michael Owyang notes at the St. Louis Fed:
Over the years, economists have discovered that the Phillips curve appears to shift. These shifts are typically attributed to changes in inflation expectations and were thought to have contributed to the period of high inflation and high unemployment in the late 1970s.
Recently, economists have questioned whether the Phillips curve relationship has broken down. As the unemployment rate has fallen during the recovery from the Great Recession, the inflation rate has stayed low, below even the Federal Reserve’s target.
He goes on to propose some explanations for why the Phillips Curve just isn’t particularly predictive.
Comes Robert Samuelson to put in his two cents about the Phillips Curve in his column at the Washington Post:
Economists from the Bank for International Settlements (BIS) in Basel, Switzerland — a bank for government central banks — find that the pass-through from wage increases to price increases has weakened. If this is confirmed and continues, it implies that inflation will remain tame for some time even if the economy continues to grow.
Just what caused the breakdown of the old Phillips Curve relationship isn’t clear. Nor is it clear whether the shift is permanent. Arguably, it might just reflect an ongoing hangover from the Great Recession. Firms raise prices reluctantly, because they fear losing sales.
In a public presentation, Claudio Borio, head of the BIS’s Monetary and Economic Department, offered another explanation. It’s globalization: the expansion of so-called global value chains — supply chains that manufacture components for a final product in many countries.
Facing higher costs, companies can relocate production to countries with cheap labor or superior production technology, a.k.a. “automation.†In the past quarter-century, there has been a vast expansion of global labor markets, Borio noted. Businesses that are mobile have undermined workers’ bargaining power.
A solution better than trying to “calculate a new Phillips Curve” might be to realize that moving a single country’s economy in one direction or another, rather as a sailor changes the direction of his boat by tacking, is impossible in a global economy. The U. S. isn’t just importing goods from China; it’s importing deflation which the Chinese exchange for inflation. Now repeat that 200 times with 200 different actors moving in 200 different directions for 200 different reasons.
