The Failed Keynesian Phillips Curve

September 27, 2009
Don't Worry About Inflation?

Everyone should worry about inflation. It's been the long-term trend for a century. You can worry about deflation too if you like. I am. Not worrying about either of them is a great way to lose one's nest egg.

Here's an update to my chart within the link. I've improved upon it by comparing the inflation rate over the previous 12 months to the average unemployment rate over the previous 12 months. It's now more of a direct apples to apples comparison. The conclusions remain the same though.



What pattern do you see in the data? I see a cumulus cloud formation. Maybe I can be an economist too? The trend line isn't exactly backing the Phillips Curve theory either, is it? If anything, it suggests that higher unemployment and higher inflation in that very noisy data set go hand in hand.

Phillips Curve

In the years following Phillips' 1958 paper, many economists in the advanced industrial countries believed that his results showed that there was a permanently stable relationship between inflation and unemployment. One implication of this for government policy was that governments could control unemployment and inflation with a Keynesian policy. They could tolerate a reasonably high rate of inflation as this would lead to lower unemployment – there would be a trade-off between inflation and unemployment.

...

Like the expectations-augmented Phillips curve, the New Keynesian Phillips curve implies that increased inflation can lower unemployment temporarily, but cannot lower it permanently.

If the Fed's actions cannot permanently lower unemployment, then that would mean that the Fed is powerless to fulfill one-half of its dual mandate.

April 10, 2007
Monetary Policy and the Dual Mandate - Governor Frederic S. Mishkin

The first challenge is determining how to interpret the dual mandate. Of course, the Federal Reserve doesn't take a literal approach to the goal of maximum employment. In that case, our policies would need to be directed at getting everyone to work at least one hundred hours a week, and we would have to discourage senior citizens from retiring and young people from attending college instead of entering the labor force.

The Fed's policies certainly did help discourage some senior citizens from retiring. First, the Fed wished to punish savers on fixed incomes in order to entice them into taking on more risk. Second, those who took the bait saw their retirement accounts decimated. Apparently it hasn't helped our economy all that much though. Go figure.

Furthermore, every modern economy has a certain level of "frictional" unemployment, which reflects the transitory periods over which individuals remain voluntarily unemployed while searching for a new job. Partly for these reasons, Federal Reserve officials and other policymakers often refer to this aspect of the dual mandate as the goal of maximum sustainable employment, and they place particular emphasis on the word sustainable.

In that case, our unsustainable trade deficit and our unsustainable growth in credit would imply that the Fed knows we are sustainably @#$%ed.

October 19, 2009
Asia Said to Be Leading the Globe Out of Crisis

But Mr. Bernanke also warned that huge trade imbalances between the United States and the rest of the world had played a central role in the global economic crisis and that they could do so again.

What might his solution to the problem be?

“The United States must increase its national saving rate,” he said.

And how would Ben Bernanke implement his solution to the problem?

August 25, 2010
FED TO SAVERS: DROP DEAD

The current Fed policy fits nicely with the Obama Administration's aim to increase spending (both consumer and Congressional) of all kinds -- a policy which discourages any kind of saving and applauds any kind of spending.

Fantastic.