Let’s start with the Fed’s goofy sacrifice ratio, which basically refers to how much unemployment has to go up in order to bring inflation down. I call this economic garbage the “Phillips curve in drag,” because over the last 25 years, unemployment and inflation have actually moved in tandem and they have both moved down. In other words, as inflation slows, unemployment comes down because the economy is strong. (If you look at their relationship during the 1970s, you would see unemployment and inflation both moving higher.) The fact is, strong growth coexists rather nicely with low inflation. And since inflation is too much money chasing too few goods, then if you’re producing more goods that absorb the money supply, especially with low tax rates to produce more goods, then why should we fear growth?
One would think Kudlow would have been avoided stepping into this debate given how KNZN ripped apart Art Laffer:
It appears that, all these years that I’ve been studying the Phillips curve, I’ve been under a wrong impression about what the Phillips curve was. You see, naïve as I was, I thought that demand was the causal factor. I thought that excess demand caused both faster growth and rising inflation rates. I had this crazy idea that maybe, faced with excess demand, firms would both raise prices and increase production, thus increasing the inflation rate and increasing the growth of output at the same time. And I also thought that this excess demand would give firms a reason to hire more workers, even if they had to pay higher wages to do so, so the unemployment rate would fall and wages would rise. Seems like a pretty reasonable theory to me; I doubt you would have to dig very far down in the duffle bag to find an economist who believes it. But apparently, this is not what the Phillips curve is about. No, according to Laffer, the Phillips curve is the idea that growth itself causes inflation. That is a really dumb theory. No wonder so few of us actually believe it. All this time I thought I believed in the Phillips curve, when actually what I believed was something quite different.
Or as we noted here:
KNZN nails Laffer on not knowing the difference between SHIFTS OF a curve versus SHIFTS ALONG a curve.
Kudlow makes the same mistake. The 1970’s were seen as outward shifts of the short-run Phillips curve (cost push theories, Friedman expectation theories, etc.) not movements along. But let’s review the history of inflation since Clinton took office in our first graph.
Oh – very little change in the unemployment rate with a lot of noise in the inflation rate. OK, let’s consider the Reagan-Bush41 years. Except the only real noise comes during the early disinflation period – and guess what? Unemployment was high.
OK, we could graph the Phillips curve for the entire period from 1981 and see little correlation. But would one be surprised that during a period where the shifts of the curve likely dominated the movement along a short-term curve that we would see little correlation? But if Kudlow sees a strong positive correlation – I have to ask: what is he smoking?
Update: Mark Thoma responds to my email to provide a few comments regarding Kudlow’s latest confusion. Mark does a very nice job of framing the debate over the Phillip’s curve.
Update II: KNZN writes:
either Larry Kudlow is trying to pull the wool over people’s eyes, or he is somehow unaware of the last 40 years of Phillips curve research. His argument essentially goes like this: the Phillips curve is an inverse relationship between unemployment and inflation. What we observe, however, is that the relationship is positive, not inverse. Therefore the Phillips curve is wrong. That might be a strong argument against the version of the Phillips curve that was widely believed during the 1960s (the “groovey” Phillips curve, as Gabriel Mihalache called it in an earlier comment). That version posited a stable relationship between the unemployment rate and the level of inflation, the same relationship in the long run as in the short run. The problem is, nobody believes in that version of the Phillips curve any more. Don’t even bother looking in the duffle bag. That argument was settled conclusively before Bill Gates dropped out of college. For practical purposes, the Phillips curve – the version that is used to guide forecasts and generate policy prescriptions today – is not a relationship between unemployment and the level of inflation; it is a relationship between unemployment and the change in the inflation rate.
The other vowelless economist blogger proceeds to graph the data and concludes:
I don’t know about you, but that sure looks like an inverse relationship to me. Want to include the 1970s? OK.
All I have to say is – GROOVY!