Wall Street Journal Declares There is No Phillips Curve

It would not be news to suggest the op-ed pages of the Wall Street Journal often contain some really stupid comments, but this takes the cake:

Here we go again, back to the era of the Phillips curve, the economic theory that postulates a trade-off between inflation and unemployment. We thought Paul Volcker and Alan Greenspan had buried that notion years ago.

Mark Thoma responds:

If there is no short-run tradeoff between output/unemployment and inflation, then the WSJ editors should have no objection to the Fed raising the federal funds rate (i.e. cutting money growth) by whatever amount is necessary to hit, say, a 1% inflation rate in 3-6 months (with no short-run tradeoff, this amount of time isn’t needed, but let’s not be overly demanding). Rates of 15%, 20%, 25%? 50% if needed? No problem. It doesn’t matter how high rates go, unemployment and output won’t change in the short-run – so just get rid of inflation no matter how high rates need to go. I bet the WSJ editors, and their readers in the business community, would worry about GDP falling. If so, they believe in a short-run Phillips curve no matter what they say in public. Their idea of the short-run might be a shorter time period than mine, and that can affect policy choices, e.g. how aggressive to move against inflation, but that’s a matter of degree, not substance.

While I agree with Dr. Thoma, let me suggest why this rebuttal is not sufficient. Mark and I likely did our graduate work in economics around the same time during the era that followed Milton Friedman’s 1968 Presidential address. Friedman was suggesting there was no long-run tradeoff, which is now a very well accepted proposition, but also argued there was a short-run tradeoff. In my view, his market clearing model with adaptive expectations was doomed from the start as all a few other very bright economists (e.g., Thomas Sargent and Robert Lucas) had to do was to combine market clearing with rational expectations and the theoretical case for a short-run tradeoff evaporated.

Those of us who question whether labor markets quickly clear might also ask – what is the historical record with prior episodes of using tight monetary policy to reduce inflation? I have chosen two periods of time with the first being a period surrounding Friedman’s 1968 Presidential address. The critics of Keynesian thought often point to the acceleration of inflation during the late 1960’s, which in my view is a dishonest argument given the fact that the Keynesian economists on President Johnson’s CEA were arguing for aggregate demand restraint as early as December 1965. The fact that the politicians ignored the CEA recommendations preferring to listen to crackpot Norman Ture (the mentor of the free lunch supply-side lunatics that the WSJ editors worship) is not a condemnation of Keynesian thought. The record of unemployment from 1966 to 1971 shows that unemployment did decline during the period of rapid aggregate demand growth and that it did increase when the Federal Reserve during the early days of Nixon’s Presidency followed Dr. Friedman’s advice.

The second episode from 1979 to 1982 shows the record of the Volcker Federal Reserve as it tried to reduce inflation through tight monetary policy. We began with the Carter recession (1979-1980), which was followed by the anemic Carter recovery (1980-1981) as Volcker temporarily backed off from his tight monetary regime. The next step was quite unfortunate as a group of free lunch supply-side lunatics convinced President Reagan to adopt a policy of long-run fiscal insanity, which prompted the Volcker Federal Reserve to adopt round II of tight monetary policy. Now if the editors of the Wall Street Journal are correct that the short-run Phillips curve did not exist, my graph which shows the rise in the unemployment rate is a bit of data these editors need to explain – assuming they know to recognize the historical record.