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The Tyranny of the Phillips Curve

Posted on Thursday, December 21, 2023
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by Outside Contributor
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Phillips curve text Concept Closeup. American Dollars Cash Money, 3D rendering. Phillips curve at Dollar Banknote

Repeat after me, class: Growth does NOT cause inflation. Write it on the blackboard 100 times.

For decades, the economics profession has been trying to tell us all just the opposite. They keep shoveling out the dumbest economic concept of all time: the Phillips Curve. This was the lame-brained “theory” by neo-Keynesian economists of the 1960s and 1970s that to slow inflation, the Federal Reserve needs to raise unemployment and slow down economic growth.

The whole concept of an inverse relationship between unemployment and inflation blew up when it was put into practice in the mid-1970s and the result was rising inflation AND rising unemployment. Then in the 1980s and ’90s, with free-market supply-side policies in place, we had low inflation and low unemployment.

Over the past 40 years or so, if there is a relationship between unemployment and inflation, they tend to run together more often than in an inverse relationship. As my colleague at the Committee to Unleash Prosperity, David Simon, puts it: “The historical evidence shows the opposite of the Phillips Curve theory: increasing inflation in a particular year increases the unemployment rate in the following year  and that reducing inflation in a particular year reduces the unemployment rate in the following year.”

This concrete evidence should be the end of the myth of the Phillips Curve. Except that we’ve learned in recent years that when the Left’s theories are contradicted by the real world, they stick with the theory. If the laboratory mice aren’t behaving as predicted, the problem isn’t the theory; it’s the mice. 

Which brings us to the high priests in the temple of the Federal Reserve Board  who gave us 9.2% inflation last year. Now what are they doing? Still singing out of the discredited Phillips Curve hymnal. Just listen to Jerome Powell explaining the Fed strategy back in August: “Getting inflation sustainably back down to 2% is expected to require a period of below-trend economic growth as well as some softening in labor market conditions”  i.e., fewer people working.

Then there was this from Fed Governor Christopher Waller explaining the latest Fed decision: “While I am encouraged by the early signs of moderating economic activity in the fourth quarter, inflation is still too high.” Then he added: “I am increasingly confident that policy is currently well positioned to slow the economy and get inflation back to 2%.”  Christopher Waller, Nov. 28, 2023 (emphasis added).

This is dangerous nonsense. As economist Louis Woodhill has explained it: “It is as if the Fed is trying to stop a careening car headed over a cliff by turning on the windshield wipers.”

We aren’t anywhere close to real full employment in this country. We still have 5 to 6 million working-age men out of the workforce  the vast majority of whom could and should be working. The economy’s average growth post-COVID over the last two years has averaged less than 2% when the historical average is in the 3% to 3.5% range. So the Fed is delivering that below-trend GDP they’ve been hoping for.

Some of the problem is the mandate for the Fed as dictated by Congress to deliver an American economy that achieves “stable prices and full employment.” But this is redundant. One of the surest ways of achieving full employment is precisely to stabilize prices. Instead, the more than 300 Ph.D. economists at the Fed and the Board of Governors are under this weird spell that full employment actually creates inflation.

The Fed should have long ago tossed out the Phillips Curve sophistry. They’ve completely misdiagnosed the inflation problem. Bidenflation wasn’t caused by too many people working or any sudden spurt of economic production since 2021. It was fueled by runaway government spending, debt and a vastly expanded Fed balance sheet, which pipelined excess dollars into the economy. And so the Fed seemed to be squelching private-sector growth at the same time we need more of it.

As Arthur Laffer has put it: “If the economy produces more apples, the price of apples goes down, it doesn’t go up.” The reason that the pro-growth movement is called “supply-side economics” is that the goal of any well-run economy should be to increase the production and “supply” of goods and services. 

This Fed is for private-sector austerity, but they are fine with government growth. Half of the new jobs in the economy this year have been in government or health care. Unlike Fed chairmen of the past, including Paul Volcker and Alan Greenspan, who routinely criticized Congress for its addiction to debt-financed spending, Jerome Powell rarely jawbones Biden or Congress to spend less money. This would be far more effective than raising interest rates and slowing down the economy, which only makes the cost of the federal government’s borrowing even more expensive. 

What Americans want right now is prosperity. Neither Congress nor the Fed are taking us there. Then they wonder why 70% of voters are unhappy. 

Stephen Moore is a senior fellow at the Heritage Foundation and an economist with Freedom Works. His latest book is: “Govzilla: How the Relentless Growth of Government Is Devouring Our Economy.”

Reprinted with permission from CFIF.org – By Stephen Moore

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PaulE
PaulE
3 months ago

As someone who worked for the Federal Reserve for thankfully a relatively short period of time but many years in the financial sector, our current inflation was caused by excessive fiscal stimulus, the usual backward-looking Fed Reserve and bad economic policies from the Biden administration. When President Trump left office the rate of inflation was 1.4% and the Federal Reserve was worried how they would increase inflation to hit their arbitrary 2% annual inflation rate. That latter point is something we can discuss another day as it is insane for a Federal Reserve, with a mandate to maintain the stable value of the U.S. dollar to consider a annual monetary depreciation rate of 2% per annum sound monetary policy.

This current round of excessive inflation was NOT caused by either increases in economic productivity nor job growth. So, the Federal Reserve hiking interest rates to cause an intentional recession to reduce economic activity, while the federal government continues to want to spend more and more money, by borrowing it from foreign nations and individuals, is literarily defeating all the Federal Reserve’s attempts to reign in the excessive inflation.

Up until Biden tripped into the White House, this nation had NOT suffered this level of inflation since the ruinous Carter years. Biden curtailing our domestic energy production, which in turn sent ripples of supply shocks and higher energy costs throughout the economy was like throwing gasoline on a lit match and wondering why things start burning all around. Couple that with a series of ruinous domestic and foreign policy decisions, as well as the standard solution of most members of Congress to just throw more money at whatever problem happens to be the hot topic of the moment via ludicrous and poorly thought-out spending bills, and what you have is your standard government created problem with the same government stumbling around trying to solve what they broke.

The losers in all this are of course the American people, who get stuck with the bill and the fallout from a federal government that for the most part has no real understanding or interest in either sound monetary theory or sound economic policies. As Reagan used to say, the worst words you can here are “I’m from the government and I’m here to help”. That usually means you need to grab ahold of your wallet and run in the opposite direction as fast as possible, because the last thing you’re likely to receive is a competent solution from the federal government.

David Millikan
David Millikan
3 months ago

I agree with Kim and PaulE on their observations.

Kim
Kim
3 months ago

Liberals are as likely to decry the Phillips curve as they are to uphold trickle-down economics. The Fed’s decision to raise interest rates while the government spent us into near-destitution caused this high inflation, mediocre employment (still a low labor force participation rate), and the inability for young working couples to afford a home of their own. Throw in loss of border security, mismanagement of energy resources, weaponization of the DOJ, the FBI, and the IRS, and now we’ve got something to worry about.

Rob citizenship
Rob citizenship
3 months ago

This is a mentally stimulating ,thought inspiring article Mr.Moore. Well done with what you wrote here. If economic policy that is just plain good common sense is thrown out the window — then what else will follow ? One thing that will probably go next will be hope and hope stimulates the sort of thinking that builds incentive . Some very basic ideas that are adhered to when it comes to economic policy will usually suffice in order to keep the gears of prosperity meshing and turning properly. There are right times to do certain things , certain circumstances will indicate following a course in the desired direction . The economic policies that favor including respect for people and how people of good character and high intelligence should be considered at all times will make adjustments naturally if plans go off course. Good common sense can be the scale to balance financial matters properly . It is a matter of providing a foundation of economic thought that is clear , based on intelligent planning and organization . Great article Stephan . With respect.

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