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The Phillips curve is still dead

Summary:
Greg Mankiw posted a clever graph a month ago, which he titled "The Phillips Curve is Alive and Well."No, Greg, the Phillips curve is still as dead as Generalissimo Franco.The lines, in case you can't see them are the employment-population ratio 25-54, and the average hourly earnings of production and nonsupervisory employees. Wait a minute, ...

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Greg Mankiw posted a clever graph a month ago, which he titled "The Phillips Curve is Alive and Well."

The Phillips curve is still dead

No, Greg, the Phillips curve is still as dead as Generalissimo Franco.

The lines, in case you can't see them are the employment-population ratio 25-54, and the average hourly earnings of production and nonsupervisory employees. Wait a minute, the Phillips curve, as it appears in contemporary macroeconomics, is a relation between inflation, a coordinated rise in prices and wages,  not real wages or hourly earnings, and unemployment or the output gap, not the employment-population ratio. How does the traditional Phillips curve look? Here is unemployment vs. CPI inflation

The Phillips curve is still dead
and here is inflation vs. the GDP gap:

The Phillips curve is still dead

Here is "core" (less food and energy) inflation vs. unemployment:

The Phillips curve is still dead

Except for one little blip in the depths of the 2009 recession. The Phillips curve is dead. (Long live the Phillips curve, the crowd sings nonetheless.) Inflation trundles along, ignoring unemployment or the output gap.

What's going on? Primarily, I think Greg goes deeply wrong in looking at average hourly earnings, or wages for short. The whole art and magic of the Phillips curve is about inflation, the rise in both prices and wages.  Greg's graph is perfectly sensible microeconomics. The labor market is tight, demand for labor is high, you have to pay people more to get them to work. The rise in wages is a rise in real wages, a rise in wages relative to prices.

Similarly, one might imagine tight product markets, with strong demand, as a time that output prices and measured inflation would rise relative to wages.

The puzzle and promise of the Phillips curve is the idea that tighter labor markets, traditionally measured by the unemployment rate, correlate with higher wages and prices. That takes more doing. Typically, you have to think that workers are fooled into working for what they think are higher real wages, and only later discover that prices have gone up too. And you have to think that firms rather mechanically raise prices passing on higher labor costs, and keep selling things when they do. Despite the intuitive appeal of tight markets leading to rising prices and wages, that simple intuition is wrong to describe a correlation between tight markets and both prices and wages, which is what the Phillips curve is and was.

The employment-population ratio is a little bit curious but less so. Much modern labor economics doesn't focus on unemployment.

What is happening should be cause for celebration by the way -- real wages are rising. From growth to inequality to the hand-wringing about declining labor share, it's hard to find anything bad to say about that!

Greg's "Phillips curve" also does not extend backwards. Here's what happens if. you push the data slider to the left on Greg's graph, going back to the 1960s rather than start in 1990:


The Phillips curve is still dead

Greg's correlation is absent in the heyday of the Phillips curve. Greg's alive Phillips curve was born in 1990.  (What you're seeing is, of course, the rise in labor force participation, particularly among women, until 1990.) That's why the traditional (ex ante!) Phillips curve really was about gap measures

The conventional inflation-unemployment Phillips curve also died just about contemporaneously with the Generalissimo:

The Phillips curve is still dead

The negative correlation which Phillips noted around 1960 turned to a positive, or stagflationary correlation in the 1970s. One nice negatively correlated data point in the disinflation of 1982 is it.

The policy world, including the Fed, ECB, and related institutions, continues to believe in the Phillips Curve, and as causation not just correlation: tight labor markets cause inflation. But its evident death is causing some unsettled feelings for sure.

*****

Catching up on Greg's blog, I also found a lovely and sage quip:
Washington Post columnist Robert Samuelson argues "It’s time we tear up our economics textbooks and start over." He uses my book as a prime example. Perhaps not surprisingly, I disagree. My summary of Samuelson's article: Economics textbooks should be more like economics journalism, says an economics journalist.
There is so much "starting over" in the air -- modern monetary magic on the left, neo-mercantilism on the right -- that understanding long settled questions is indeed what education should be about. (And not just the sharing of untutored opinions.)
Textbook writers, on the other hand, emphasize those things that are true, important, and unknown to the typical reader (an 18 year old college freshman). Newness has little relevance. The lessons of Adam Smith do not apply only to the 18th century, the lessons of David Ricardo do not apply only to the 19th century, and the lessons of John Maynard Keynes do not apply only to the 20th century. They are timeless ideas that may not make good news stories but should be central to introductory economics. Just as Newtonian mechanics should remain central to introductory physics.
Well, I think Keynes will go the way of phlogiston, but I agree with the point, and anyway a good 19th century scientist should know what phlogiston is.
John H. Cochrane
In real life I'm a Senior Fellow of the Hoover Institution at Stanford. I was formerly a professor at the University of Chicago Booth School of Business. I'm also an adjunct scholar of the Cato Institute. I'm not really grumpy by the way!

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