The Phillips curve in the 21st century (or, The Phillips curve as a 3 dimensional foil)
by New Deal democrat
The Phillips curve in the 21st century (or, The Phillips curve as a 3 dimensional foil)
This is my third post about the possibility of the Fed raising rates as early as June.
In the first post, I pointed out that both wage growth and inflation are at historic, half-century lows. Further, the heightened number of involuntary part-time employees and those who want a job now, but have completely given up looking, suggest additional slack as compared with other instances of 5.5% unemployment, There is not the slightest pressure on inflation from wages at present.
In the second post, I showed that since the turn of the Millennium that CPI inflation, ex-Oil, has never exceeded 3%, even with 4% unemployment or 4% YoY wage growth. Further, it is likely that core inflation in the next 12 months will actually decrease somewhat as the collapse in oil prices feeds through the economy.
Now let’s look at the 21st century Phillips curve, i.e., the tradeoff between inflation and unemployment.
To begin with, the Phillips curve is regaining respectability as some economists (pdf) consider it is not a 2-dimensional curve, but a 3-dimensional foil, similar to this graph, which was the best visualization of the concept I could find:
The insight is that labor is one of many commodity inputs. A significant change in the cost of other commodities changes how much labor can be profitably employed. Thus the third dimension is the cost of non-labor commodities, and in particular Oil. An exogenous shock such as the 1974 Oil embargo, which suddenly and dramatically increased the price of a basic good, will shift the 2 dimensional Phillips curve along the third axis.
[Note: I apologize for the non-uniformity of the graphs below. Some were prepared quite some time ago, under the “old” FRED. The new and allegedly “improved” FRED is considerably less functional. I traded uniformity for clarity of presentation.]
So let’s generally divide time periods into low and high priced oil. I’ll start by showing the inflation-adjusted price of Oil:
The regimes are: (1) low prices from 1948-73; (2) high prices from 1974-85; (3) low prices from 1986-2000; and (4) high prices from 2001-14.
Here’s the Phillips curve datapoints for each (The y axis is the unemployment rate. The x axis is the YoY% change in headline inflation):
1. Low prices from 1948-73:
2. High prices from 1976 through 1985:
3. Low prices from 1986 through 2000:
4. High prices from 2001 to the present::
Notice that high unemployment in excess of about 7.5%, only occurs in the eras of high priced oil. Contrarily, low unemployment below 4.5%, only occurs in eras of high priced oil. Here’s a quick comparison of approximate unemployment rates common to all eras:
2.5% Unemployment:
Era // Inflation
1948-73 // 7%
1974-85 // 10%
1986-2000 // 7%, 4%
2001-14 // 10%
5.5% Unemployment:
Era // Inflation
1948-73 // 4%
1974-85 // 7.5%
1986-2000 // 4.5%
2001-14 // 5.5%
The Phillips curve has shifted upward and outward on the 3-dimensional foil during periods of high oil prices.
For the rest of this piece, I’m going to focus on the era of 2001-present.
As you can see from the final graph above, headline inflation has almost always exceeded the Fed’s 2% target in times of 5.5% unemployment or less.
But as I showed yesterday, ex-Oil inflation since 2001 has never gotten above 3%. Here’s the Phillips curve for unemployment vs. CPI less energy:
It’s still true that at 5.5% unemployment or less, CPI inflation ex-Oil is over 2%. But at the absolute worst it is no more than 3%.
Finally, here is the Phillips curve of unemployment vs. core inflation. Craig Eyermann of Political Calculations graciously calculated a regression. Note that the axes are reversed compared with previous graphs):
Similarly, the worst inflation is less than 3%, even at 4% unemployment.
Granted that under all 3 inflation calculations, since the year 2000 an unemployment rate under 5.5% has almost always correlated with an inflation rate in excess of 2%. But even so, even if the unemployment rate should fall as low as 4%, the risk is that we overshoot 2% YoY CPI by less than 1%.
Further, if we have at least temporarily entered a period of low oil prices, then the Phillips curve should once again shift downward and to the left on the 3-dimensional foil, and there is evidence that it is already doing so, as shown in this graph zooming in on the last 5 years:
As Oil prices rose by 40% YoY in 2011-12, the inflation rate hit 3% even with high unemployment, but since then the Phillips curve has shifted downward and to the left as gas prices stabilized. Further, note the two overlapping dots at 5.6-7% unemployment and 1.88% CPI less energy. The Phillips curve is now shifting even further downward and to the left in response to the collapse in gas prices. Thus, consistent with the late 1990s and the post WW-2 period, we could have as low as 4% unemployment without inflation exceeding 2%.
Considering we have just endured 5 of 6 years with inflation under the Fed’s target with subpar wages and high unemployment, the risk of a 1% overshoot — or possibly no overshoot at all! — hardly justifies tamping down on improvements to laborers.
cross posted with Bondadd blog
Dude, look at real wages. What “big” slack? Posts like these show what a fool you are. There is indeed wage growth.
John,
Chart the 80% non supervisory etc. work force wages and the 20% supervisory etc group from the BLS. I can find the link to stats sometime this weekend. Wages are increasing for the top 20%, which is what makes the little growth show up in the overall stats. The bottom 80% NOT.
You wrote: “There is not the slightest pressure on inflation from wages at present.”’
Agreed
You wrote: “Further, it is likely that core inflation in the next 12 months will actually decrease somewhat as the collapse in oil prices feeds through the economy. “
Yes, but since core inflation excludes energy, the effect should be minor. And I would argue that at least part of the reason that oil prices are collapsing is that the FED is threatening to raise interest rates. Thus fear is making it more difficult to speculate in the oil commodity. That added to slowing demand and rising supply has made for a rapid turnaround in what I consider to be an oil bubble that has been building since 2002. It was interrupted by the Great Recession in 2008 and resumed in 2010
You wrote: “Considering we have just endured 5 of 6 years with inflation under the Fed’s target with subpar wages and high unemployment, the risk of a 1% overshoot — or possibly no overshoot at all! — hardly justifies tamping down on improvements to laborers.”
Your graphs seem more like Rorschach images. You see order, and I see too much chaos.
The Philips curve is too simplistic to represent reality over the long term. Adding the price of oil is not an adequate improvement. If you insist on pursuing this line then you should try using imports vs exports as the 3rd dimension. Even that improved curve will have excessive noise in it.
The Philips curve could not cope with oil prices increasing by a factor of about 5 from 1972 to 1980 which caused rampant inflation. American workers still had the power to demand wage increases or they would quit. We had stagflation. From 1973 to 1980 the economy was impaired by Opec’s oil prices, then from 1980 to 1986 that impairment was slowly reduced.
And it can not cope with the oil bubble created and maintained from at least 2002 to 2014. Speculators were at work in the dot.com bubble and never really went away, they just switched their field of interest.
And it can not cope with an economy that since the late 1980s has seen more and more workers stripped of the power to negotiate higher wages. The predominant mechanism was the movement of production overseas. And that situation has gotten worse and worse for the American worker/consumer.
You argue for keeping interest rates at effectively zero. If the FED does that, we will get more of what we have had over the last 7 years since the beginning of the Great Recession. Depressed wages, excessive true inflation, and rampant speculation in commodities. (True inflation as opposed to the fiction printed by the federal government.)
I argue for letting the FED raise interest rates. It will drive out the speculators. With a little luck we will get deflation or at least very low true inflation. Depressed wages deserve depressed prices. Let’s try that for 7 years.
An interesting proposal….deflation for the wage earner.
To: John Cummings:
You wrote:
“Dude, look at real wages.”
Dude, all of the growth in real wages is because of the collapse in the prices of commodities, especially oil. Nominal wage growth, which is what the Fed cares about in consideration of NAIRU, which is by the way the subject matter at hand, is at a historic low.
“Posts like these show what a fool you are.”
Umm, dude, that’s a mirror you are looking at.
NDd:
Good Reply
Bottom 80% are the ones getting the boost in real wage increases. What a hogwog post. You just don’t want to admit that we are growing through oil based disinflation. Your ideology is overwhelming you.
Well John,
Your tone itself makes for no communication. Check with stats. Perhaps you are thinking of the minimum wage increases voted in by a number of states? We prefer empirical data.