By Justin Lahart of The Wall Street Journal. This article discusses the Phillips curve. It is related to Monday's post on full employment. The link to that post and many other previous posts (some with graphs) on this topic are listed after these excerpts from the Lahart article: "in the years spanning 1861 to 1957 the unemployment rate and wage inflation in the U.K. were negatively correlated—meaning that when one went up, the other one tended to go down, and vice versa.That makes sense: When unemployment is low, workers can bargain for bigger wage increases than they can when unemployment is high.American economists Paul Samuelson and Robert Solow seized on Mr. Phillips’s work, showing in a 1960 paper that it applied to the U.S. as well.""People’s inflation
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"in the years spanning 1861 to 1957 the unemployment rate and wage inflation in the U.K. were negatively correlated—meaning that when one went up, the other one tended to go down, and vice versa.
That makes sense: When unemployment is low, workers can bargain for bigger wage increases than they can when unemployment is high.
American economists Paul Samuelson and Robert Solow seized on Mr. Phillips’s work, showing in a 1960 paper that it applied to the U.S. as well."
"People’s inflation expectations matter, as economists Milton Friedman and Edmund Phelps pointed out in the late 1960s and America painfully learned in the 1970s.
The basic insight is that inflation expectations play a role in bargaining over wages. If the unemployment rate is 5% and workers think that prices will rise by 10% annually, they will demand bigger wage increases than they would if they think inflation will be 2%.
Those inflation expectations, meanwhile, are shaped by people’s past inflation experiences. So when inflation started shifting higher in the late 1960s, driven in part by government spending programs that drove the unemployment rate down, inflation expectations eventually shifted higher as well. The Phillips curve shifted higher as a result, so that any given level of unemployment was associated with much higher inflation than it had been in the past. The Great Inflation had arrived.
It didn’t break until the early 1980s when the Fed, under Chairman Paul Volcker, slammed the brakes on the economy, driving inflation down and resetting inflation expectations lower. Over the next two decades, the central bank, guided by a Phillips-curve framework, kept a tight lid on inflation.
But since the early 2000s, and especially since the financial crisis, the Phillips curve hasn’t been behaving like economists thought it would. When the unemployment rate shot higher following the financial crisis, inflation fell less than Phillips curve models predicted. And when the unemployment rate fell to 3.5% in late 2019, inflation was remarkably muted."
"Some people have suggested that, as a result of forces such as globalization and the reduced bargaining power of workers, the Phillips curve relation is broken.
That probably isn’t true. An economy where wages and inflation don’t have something to do with the supply of labor would be a strange one. Indeed, research conducted by economists Peter Hooper, Frederic Mishkin and Amir Sufi shows that at the local level in the U.S., the Phillips curve is working quite well, with changes in metropolitan area unemployment negatively correlated with changes in the rate of inflation."
"Technology may have made it easier for employers to find employees, for example. And an increased willingness to hire and promote women and minorities may have led businesses to take on workers who in the past were underutilized.
Another possibility is that after years of persistently low inflation, inflation expectations have become so set that changes in the unemployment rate affect inflation less than in the past."
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