The stakes are too high to use the Phillips Curve with its unreliable tradeoff between unemployment and inflation. We don't need millions of Americans out of work. We need investments in our future.
Concur. Thank you. We, society, must prioritize the dignity of the human vice money. Fiat currency provides the US the time and space to achieve this priority. Keep educating via this forum Claudia.
There is some justification for rent control in that scenario- since we can't build housing instantly in response to rapidly raising demand, we would still see a big bump in rents from that demand before new supply lowers it down again. Well designed rent control can help alleviate that.
For example, we could have rent control that limits increases to 10% plus inflation per year, which would allow builders to still be attracted by higher prices while spreading out the impact for tenants. We could also have rent control on buildings older than 15 years, which would avoid any decreases in new build housing because housing investors typically have a 15 year timeframe for returns for their investment.
“High interest rates make it more costly to make all these investments.” How does this itself not reinforce the inflation cycle? We are fighting high prices by raising prices. How is that consistent with the Fed’s “stable prices” mandate? Genuinely baffled as to why there isn’t more institutional pushback on this concept. Comments from Fed officials suggest frustration with how persistent inflation has been. It seems like they think they are spraying water on the inflation fire but in reality are spraying gasoline.
Much of our inflation was caused by an economy that was not resilient to shocks, such as the commodity shortages caused by Putin and OPEC. We must invest in energy (renewables and traditional sources). It will take years for that to be in place. We cannot delay a year with the Fed jacking up rates so much. that's one example of many.
Thank you for the reply Claudia. Totally agree! What I can’t really get my head around is that in prior shocks - such as the COVID shock and the GFC - the Fed’s reaction was to lower rates. Why would the Putin war shock be treated differently? Seems arbitrary, no? Wouldn’t keeping the cost of funds low help offset the commodity price spikes? There are CPG companies raising prices double digits despite volumes (i.e. demand) being down. We had zero or near-zero rates for over a decade, and inflation was “stubbornly low.” Similar experience in japan. Now, we jacked rates up and inflation has been “stubbornly high” (albeit coming down, to your points). Japan has kept their rates near zero and have the lowest inflation in OECD. At the risk of sounding like a conspiracy theorist, and recognizing there are incredibly bright, accomplished economists working at the Fed, but it seems to me like they have this whole thing backwards, and the lack of institutional pushback is frustrating.
We aren’t raising prices of goods and services, but we are raising the cost of borrowing money. Interest sensitive investments are the one’s a company makes with borrowed money. Those investments are not happening as much now that the cost of being in debt is increasing. This slows down aggregate demand for goods and services so that there aren’t as many shortages, and thus price levels begin stabilizing.
“Interest sensitive investments are the one’s a company makes with borrowed money.” Respectfully disagree here. ALL spending is done with money that’s is “borrowed” because all money is “borrowed.” Money is a promise/IOU. Every financial surplus has an equal offsetting deficit by definition thanks to double entry bookkeeping. The dollar bill in your pocket is ostensibly your asset and simultaneously a liability of the Federal Reserve (and therefore an obligation of the US federal government). So, raising the cost of money used to pay for goods and services raises the cost of those goods and services. Also, where are you seeing evidence of a slowdown in investment? Capital spending is +10% y/y as of 3Q, C&I loans growing steadily, consumer credit growth also growing according to data at FRED. And Atlanta Fed’s GDPNow showing +2.8% real growth so far in 4Q.
Yes all money ultimately borrowed. The fed controls interest rate for money, so when they increase interest rates, they are decreasing interest sensitive spending.
From a top-tier view, everything has interest, but from an individuals point of view we are sensitive to interest from loans. High mortgage rates only only matter if you are buying a home, for example. By raising rates, the market has cooled.
In terms of any of your data, none of it is relevant because you can have growth and decrease the rate of investment. It is not a binary world, and the fed is not targetting a recession but a soft landing. That means the fed is still trying to achieve its policy objective of 2% real growth. I would expect every graph you showed me in high inflation and low inflation times.
Thank you for the reply. Your points appear to be consistent with the prevailing economic orthodoxy. I am proposing that the orthodoxy is wrong. I challenge you to reconsider.
“When they increase interest rates, they are decreasing interest sensitive spending”
Again there is no empirical data to support this. The Fed has never produced research supporting this.
Reiterating my points from earlier: commercial and industrial loans and consumer loans are all ostensibly “interest rate sensitive spending,” and they show no signs of slowing. CAPEX is another item that is generally understood to be interest rate sensitive, and is up double digits from 2021. This has happened despite the Fed’s rate hikes. How can those data be irrelevant?
“From an individuals point of view we are sensitive to interest from loans”
Sure, but that only accounts for one side of a lending transaction. The lender is also sensitive to the interest received on a loan. Higher rates create higher income for savers. In aggregate, that higher income supports higher prices for goods and services. So higher rates raise prices while providing subsidies to savers and taxing borrowers. I don’t see how raising prices is helpful to fight inflation i.e. rising prices.
I don’t see how your point about the housing market is relevant. Houses are capital goods, not consumption goods. Home prices rise and fall based on idiosyncratic factors. By your logic, when the Fed lowered the federal funds rate from 5.25% to zero from 1Q2007 to 1Q2009, home prices should have boomed. Instead, they collapsed.
The evidence seems clear that rate hikes do not “tighten” credit. We actually used to have laws that explicitly allowed credit controls administered by the Fed - this was used by President Carter and contributed to the recession we had in 1980. However, Congress voted to do away with this provision.
I agree with most of what you say. Normally it is never different, except this time it is. The fiscal stimulus was needed but over done. The disruptions that the lockdown caused with more money in the system caused demand to outstrip supply. Then to top it off we have a war and a cycle of lockdowns in China. The only world shortage today in energy is liquefied natural gas. Russian oil is finding buyers. This will take 2 years to fix if the war lingers on. As far as the China lockdowns goes I don’t have a clue except as of today it seems better.
The Fed has changed from low cost money to now it cost. They have changed peoples/companies behavior. Where I disagree is that they must make sure inflation goes down. I lived through the inflation of the 70s/80s and it wasn’t pretty. I doubt that it will effect employment as much as then because this time really is different. Sure tech companies are laying off people but META having 15,000 people working on the metaverse is nuts. Tech companies are just adjusting to the over hiring they did in the past 2 years. Also there is much more governmental stimulus coming in the inflation reduction act and the infrastructure act plus there is 500 billion leftover in stimulus act money.
I remain an ardent supporter of the fiscal relief, though I admit that it contributed some to the inflation. a job-full recovery and more financial buffers among those who have never had one is our only shot at a 'soft landing.'
You're right, of course, but just you watch, they're going to follow the same old tired playbook until they get a recession at which point they will declare "victory" yet again. Sure -- a "victory" from the same logic that gave us "in order for the village to be saved it was necessary that it be destroyed." As Tacitus had Calgacus say of the Romans, "they make a desert and call it peace."
Have you downloaded Phillips paper? It’s not what it says. It talks about wages, not prices and includes the rate of change of employment. It’s not to say you’re not correct in getting rid of it but first, at least acknowledge that Phillips was a pretty smart guy who has been wholly misrepresented by mainstream economics.
True, Phillips's original 1958 paper only argued for an inverse relationship between the unemployment rate and the rate of increase in wages. It was Samuelson and Solow's 1960 paper that made the argument that increased wages would translate directly into general price increases and that, hence, there existed an inverse relationship between the unemployment rate and price increases -- a relationship which, when graphed, would be a downward-sloping curve that would offer "policy makers" a "menu of policy choices" over which they could "trade-off" between unemployment and inflation.
the modern versions of it are inflation-unemployment. macro also uses wages-unemployment. I am not going at Phillips the man. please read the Ball and Mankiw paper that I linked to.
I have largely agreed with your arguments as you have continued to use recent data to explain your conclusions. I think in short your argument boils down to--amongst other smaller factors-- a labor supply issue caused largely by COVID and inadequate support for US workers--which I totally agree with (correct me if I am wrong). The question I have is how do you and others get the Fed and the market to realize that this is an employer and congressional issue, that these inflationary issues are due to a lack of proper legal protections and conditions for workers instead of a simple too much demand/ Phillips Curve issue?
Some questions that came to mind while reading this post (as well as the Stiglitz paper linked in the comments):
1) Is there such a thing as inflation-contagion? Suppose that a number of large, rich countries were too generous with lockdown benefits, could this lead to inflation in other countries that were the appropriate amount of generous (whatever that means) but have economies that are well-connected to the large, rich countries?
2) How much damage do you think 'team transitory' macroeconomists did to their perceived credibility by aggressively pushing the transitory angle in 2021?
3) It seems like we're not seeing a price-wage spiral in the data, but if I judge by the news and my anecdotal experience with the people around me it definitely feels like we have the makings of a price-wage spiral. I'm more likely to encounter someone on social media talking about having their salary effectively decrease due to inflation, and more of my friends are testing the market hoping to negotiate a higher salary. Does anyone have any thoughts on this discrepancy (if it exists at all)?
I’m not an economist, but your level headed and progressive approach to the “dismal” science is very refreshing.
I am interested in writing and offering training on personal and financial well being (no financial investment advice or insurance sales). Your posts give me a great macro perspective that affects workers and consumers at the micro-level.
The Phillips Curve could make sense if there were a shock to the system that made wages too => unemployment and it was necessary for the Fed to engineer enough inflation (but not too much) to get real wages back in line. But that is so clearly NOT the case today if it ever was.
At best The Phillips Curve is a high-level regularity, but not a model from which the Fed should ever to set the values of its policy instruments. And even viewed as a reduced form of a more complete policy - outcomes model, the causality probably runs from inflation to unemployment, not unemployment to inflation.
OTOH, higher interest rates will result in an inflation targeting regime from higher fiscal deficits. Congress was right to push investment in infrastructure and net CO2 emissions reduction. It was wrong not to increase taxes to avoid higher deficits (=lower savings).
I thought I read somewhere the Phillips curve suggests a Fed rate of 7-10% to get inflation down. I think this is what you are arguing against, so it would be good to state it.
Hi Claudia. Not sure if Cory Doctorow is on your radar but I think you would appreciate today's post.
https://pluralistic.net/2022/12/14/medieval-bloodletters/
He's very dramatic in his delivery but his message is very familiar. Haven't read the Joe Stiglitz paper yet but am looking forward to it.
Stiglitz paper is well worth a read.
Concur. Thank you. We, society, must prioritize the dignity of the human vice money. Fiat currency provides the US the time and space to achieve this priority. Keep educating via this forum Claudia.
The fourth thing we need to do: build much, much more housing and implement sensible rent control to lower housing costs.
I am not a fan of rent control -- unless done really really well. I did put build more housing in my "tip of the iceberg" list.
If we reduce restriction on residential and commercial development, there would be no justification for rent control.
There is some justification for rent control in that scenario- since we can't build housing instantly in response to rapidly raising demand, we would still see a big bump in rents from that demand before new supply lowers it down again. Well designed rent control can help alleviate that.
For example, we could have rent control that limits increases to 10% plus inflation per year, which would allow builders to still be attracted by higher prices while spreading out the impact for tenants. We could also have rent control on buildings older than 15 years, which would avoid any decreases in new build housing because housing investors typically have a 15 year timeframe for returns for their investment.
Agree.
The idea is that policy makers could trade more inflation for less unemployment in the short run, but not in the long run.
Alan Blinder notes in his new book “A Monetary and Fiscal History of the United States 1961-2021”
“That view remains largely intact today, although even a short-run Phillips curve is hard to find in the US data since the late 1990.”
Alan is my all time fav economist, though I disagree with some parts of his new book.
“High interest rates make it more costly to make all these investments.” How does this itself not reinforce the inflation cycle? We are fighting high prices by raising prices. How is that consistent with the Fed’s “stable prices” mandate? Genuinely baffled as to why there isn’t more institutional pushback on this concept. Comments from Fed officials suggest frustration with how persistent inflation has been. It seems like they think they are spraying water on the inflation fire but in reality are spraying gasoline.
Much of our inflation was caused by an economy that was not resilient to shocks, such as the commodity shortages caused by Putin and OPEC. We must invest in energy (renewables and traditional sources). It will take years for that to be in place. We cannot delay a year with the Fed jacking up rates so much. that's one example of many.
Thank you for the reply Claudia. Totally agree! What I can’t really get my head around is that in prior shocks - such as the COVID shock and the GFC - the Fed’s reaction was to lower rates. Why would the Putin war shock be treated differently? Seems arbitrary, no? Wouldn’t keeping the cost of funds low help offset the commodity price spikes? There are CPG companies raising prices double digits despite volumes (i.e. demand) being down. We had zero or near-zero rates for over a decade, and inflation was “stubbornly low.” Similar experience in japan. Now, we jacked rates up and inflation has been “stubbornly high” (albeit coming down, to your points). Japan has kept their rates near zero and have the lowest inflation in OECD. At the risk of sounding like a conspiracy theorist, and recognizing there are incredibly bright, accomplished economists working at the Fed, but it seems to me like they have this whole thing backwards, and the lack of institutional pushback is frustrating.
We aren’t raising prices of goods and services, but we are raising the cost of borrowing money. Interest sensitive investments are the one’s a company makes with borrowed money. Those investments are not happening as much now that the cost of being in debt is increasing. This slows down aggregate demand for goods and services so that there aren’t as many shortages, and thus price levels begin stabilizing.
“Interest sensitive investments are the one’s a company makes with borrowed money.” Respectfully disagree here. ALL spending is done with money that’s is “borrowed” because all money is “borrowed.” Money is a promise/IOU. Every financial surplus has an equal offsetting deficit by definition thanks to double entry bookkeeping. The dollar bill in your pocket is ostensibly your asset and simultaneously a liability of the Federal Reserve (and therefore an obligation of the US federal government). So, raising the cost of money used to pay for goods and services raises the cost of those goods and services. Also, where are you seeing evidence of a slowdown in investment? Capital spending is +10% y/y as of 3Q, C&I loans growing steadily, consumer credit growth also growing according to data at FRED. And Atlanta Fed’s GDPNow showing +2.8% real growth so far in 4Q.
Hi there,
Yes all money ultimately borrowed. The fed controls interest rate for money, so when they increase interest rates, they are decreasing interest sensitive spending.
From a top-tier view, everything has interest, but from an individuals point of view we are sensitive to interest from loans. High mortgage rates only only matter if you are buying a home, for example. By raising rates, the market has cooled.
In terms of any of your data, none of it is relevant because you can have growth and decrease the rate of investment. It is not a binary world, and the fed is not targetting a recession but a soft landing. That means the fed is still trying to achieve its policy objective of 2% real growth. I would expect every graph you showed me in high inflation and low inflation times.
Thank you for the reply. Your points appear to be consistent with the prevailing economic orthodoxy. I am proposing that the orthodoxy is wrong. I challenge you to reconsider.
“When they increase interest rates, they are decreasing interest sensitive spending”
Again there is no empirical data to support this. The Fed has never produced research supporting this.
Reiterating my points from earlier: commercial and industrial loans and consumer loans are all ostensibly “interest rate sensitive spending,” and they show no signs of slowing. CAPEX is another item that is generally understood to be interest rate sensitive, and is up double digits from 2021. This has happened despite the Fed’s rate hikes. How can those data be irrelevant?
“From an individuals point of view we are sensitive to interest from loans”
Sure, but that only accounts for one side of a lending transaction. The lender is also sensitive to the interest received on a loan. Higher rates create higher income for savers. In aggregate, that higher income supports higher prices for goods and services. So higher rates raise prices while providing subsidies to savers and taxing borrowers. I don’t see how raising prices is helpful to fight inflation i.e. rising prices.
I don’t see how your point about the housing market is relevant. Houses are capital goods, not consumption goods. Home prices rise and fall based on idiosyncratic factors. By your logic, when the Fed lowered the federal funds rate from 5.25% to zero from 1Q2007 to 1Q2009, home prices should have boomed. Instead, they collapsed.
The evidence seems clear that rate hikes do not “tighten” credit. We actually used to have laws that explicitly allowed credit controls administered by the Fed - this was used by President Carter and contributed to the recession we had in 1980. However, Congress voted to do away with this provision.
I agree with most of what you say. Normally it is never different, except this time it is. The fiscal stimulus was needed but over done. The disruptions that the lockdown caused with more money in the system caused demand to outstrip supply. Then to top it off we have a war and a cycle of lockdowns in China. The only world shortage today in energy is liquefied natural gas. Russian oil is finding buyers. This will take 2 years to fix if the war lingers on. As far as the China lockdowns goes I don’t have a clue except as of today it seems better.
The Fed has changed from low cost money to now it cost. They have changed peoples/companies behavior. Where I disagree is that they must make sure inflation goes down. I lived through the inflation of the 70s/80s and it wasn’t pretty. I doubt that it will effect employment as much as then because this time really is different. Sure tech companies are laying off people but META having 15,000 people working on the metaverse is nuts. Tech companies are just adjusting to the over hiring they did in the past 2 years. Also there is much more governmental stimulus coming in the inflation reduction act and the infrastructure act plus there is 500 billion leftover in stimulus act money.
I remain an ardent supporter of the fiscal relief, though I admit that it contributed some to the inflation. a job-full recovery and more financial buffers among those who have never had one is our only shot at a 'soft landing.'
You're right, of course, but just you watch, they're going to follow the same old tired playbook until they get a recession at which point they will declare "victory" yet again. Sure -- a "victory" from the same logic that gave us "in order for the village to be saved it was necessary that it be destroyed." As Tacitus had Calgacus say of the Romans, "they make a desert and call it peace."
It's ridiculous.
I won't give up questioning the old playbook. Others are too. #goteam
Have you downloaded Phillips paper? It’s not what it says. It talks about wages, not prices and includes the rate of change of employment. It’s not to say you’re not correct in getting rid of it but first, at least acknowledge that Phillips was a pretty smart guy who has been wholly misrepresented by mainstream economics.
True, Phillips's original 1958 paper only argued for an inverse relationship between the unemployment rate and the rate of increase in wages. It was Samuelson and Solow's 1960 paper that made the argument that increased wages would translate directly into general price increases and that, hence, there existed an inverse relationship between the unemployment rate and price increases -- a relationship which, when graphed, would be a downward-sloping curve that would offer "policy makers" a "menu of policy choices" over which they could "trade-off" between unemployment and inflation.
the modern versions of it are inflation-unemployment. macro also uses wages-unemployment. I am not going at Phillips the man. please read the Ball and Mankiw paper that I linked to.
Good article
I have largely agreed with your arguments as you have continued to use recent data to explain your conclusions. I think in short your argument boils down to--amongst other smaller factors-- a labor supply issue caused largely by COVID and inadequate support for US workers--which I totally agree with (correct me if I am wrong). The question I have is how do you and others get the Fed and the market to realize that this is an employer and congressional issue, that these inflationary issues are due to a lack of proper legal protections and conditions for workers instead of a simple too much demand/ Phillips Curve issue?
Some questions that came to mind while reading this post (as well as the Stiglitz paper linked in the comments):
1) Is there such a thing as inflation-contagion? Suppose that a number of large, rich countries were too generous with lockdown benefits, could this lead to inflation in other countries that were the appropriate amount of generous (whatever that means) but have economies that are well-connected to the large, rich countries?
2) How much damage do you think 'team transitory' macroeconomists did to their perceived credibility by aggressively pushing the transitory angle in 2021?
3) It seems like we're not seeing a price-wage spiral in the data, but if I judge by the news and my anecdotal experience with the people around me it definitely feels like we have the makings of a price-wage spiral. I'm more likely to encounter someone on social media talking about having their salary effectively decrease due to inflation, and more of my friends are testing the market hoping to negotiate a higher salary. Does anyone have any thoughts on this discrepancy (if it exists at all)?
I’m not an economist, but your level headed and progressive approach to the “dismal” science is very refreshing.
I am interested in writing and offering training on personal and financial well being (no financial investment advice or insurance sales). Your posts give me a great macro perspective that affects workers and consumers at the micro-level.
I am going to become a paid subscriber.
Thank you.
The Phillips Curve could make sense if there were a shock to the system that made wages too => unemployment and it was necessary for the Fed to engineer enough inflation (but not too much) to get real wages back in line. But that is so clearly NOT the case today if it ever was.
I question whether we can ever use if reliably. And I agree it is clearly the wrong tool now.
At best The Phillips Curve is a high-level regularity, but not a model from which the Fed should ever to set the values of its policy instruments. And even viewed as a reduced form of a more complete policy - outcomes model, the causality probably runs from inflation to unemployment, not unemployment to inflation.
OTOH, higher interest rates will result in an inflation targeting regime from higher fiscal deficits. Congress was right to push investment in infrastructure and net CO2 emissions reduction. It was wrong not to increase taxes to avoid higher deficits (=lower savings).
Fiscal is a whole other can of worms ...
And inflation is not one of the worms (if the Fed does its job). :)
I thought I read somewhere the Phillips curve suggests a Fed rate of 7-10% to get inflation down. I think this is what you are arguing against, so it would be good to state it.
I go deeper than that. I don't care what 'sacrifice ratio' is, that's the tradeoff that one assumes the curve has. I am saying do not use it at all.
Explain how the 3-month moving average of inflation ending Nov-22 is only 3.7%?
Date Month-Over-Month, Annual Rate 3-Month Average
2022-01 7.7 7.7
2022-02 9.5 8.0
2022-03 14.8 10.7
2022-04 4.0 9.4
2022-05 11.6 10.1
2022-06 15.8 10.5
2022-07 -0.2 9.1
2022-08 1.4 5.6
2022-09 4.6 1.9
2022-10 5.2 3.8
2022-11 1.2 3.7
Source FRED, Total CPI.
Good article