Well, yes, and sorta

Remember the “Phillips curve”, the idea that the tighter the labour market becomes, the more it pushes up wages, and therefore inflation?

It used to be the lodestar of interest rate-setters everywhere; the lower the rate of unemployment, the higher the likely rate of inflation, and vice versa.

For much of the post-war period, the Phillips curve was as good a guide as any on the likely path of inflation, and was therefore at the heart of much central bank thinking on the appropriate monetary policy stance.

It was, as said, an observation which held true. The exact mechanism tho’, that’s a bit trickier. Yes, we can and do talk of wage led inflation. And I’m most unsure.

True, I tend to think most macroeconomics is bollocksy. Simply because we’ve not got enough observations of enough different places and times to be able to sort through all the different variations of what might be the causes. We’re still at the stage, with macro, of noting correlations but really not having a great deal of clue as to causes. That is a very personal observation tho’. And undoubtedly at least partly caused by my just not like macro anyway – saying it doesn’t work is a great way of not having to study it.

Still, Phillips Curve. I tend to think that it’s not actually of unemployment and inflation. That unemployment isn’t the true variable. Rather, it’s spare capacity – effective capacity, a new coinage, a neologism, to be akin to effective demand – in the economy that is the true variable, unemployment merely being a proxy for it.

This aids in explaining why you can shift the curve as well as move along it. Change the structure of the labour market and the unemployment rate becomes a different measure of spare capacity in the economy.

But it’s spare capacity that matters, not purely spare labour. The link is between inflation and an economy producing as much as it can – or not – given the current structure of it. Unemployment being a symptom, signal perhaps, of that capacity.

But then as I say I don’t like macro therefore don’t know much about it.

11 thoughts on “Well, yes, and sorta”

  1. It only held in the short run. Long run it’s a vertical line. Mr Goodheart probably has a view on the usefulness of the Phillips curve as an tool of macroeconomic policy.

  2. Wage-led inflation can also occur independently of near-full employment. The Callaghan years leading up to the Winter of Discontent were marked by leap-frogging wage demands by over-powerful trade unions. I could go on but I have run out of hyphens.

  3. Presumably an additional variable is whether or not the pool of available unemployed people have the necessary skills that potential employers need. If they have aptitude the employer could train them, but that would be an additional cost too.

  4. Bloke in North Dorset

    What Stoneyground said.

    Unemployment numbers and the Phillips curve may have be a useful indicator when the mass of the workforce was doing mind numbingly dull jobs on a factory floor or digging up coal, but its a lot different now.

  5. Don’t think it’s that simple, BiND. There’s a lot of jobs blocked off to people who’d be quite capable of doing them with a bit of training because they don’t have the prior qualifications required to apply for them. What you might call the HR Dept effect.

  6. I think the problem with looking at both “unemployment” and “inflation” is that the definition of the official numbers is pretty artificial, and it has changed so much over the years that comparison is useless.

    Unemployment = people not employed for the hours they want and they are looking to be so.
    Inflation = change in price of a basket of goods that does not include anything where the price rises and falls too often.

    It seems really easy to fiddle with these.

  7. Bloke in North Dorset


    Yep, lots of barriers to entry for people like thee and me. I doubt there’ll ever be another post boy to chairman story, and those putting up the barriers will be the ones shouting loudest about their progressive bona fides

  8. To me, macro has similarites to the caloric theory of thermodynamics. We have some ideas that explain a lot of what we see, but they aren’t correct in the most fundamental sense.

    Plus of course notions of liquidity exist in both!

  9. The standard explanation for why the Phillips Curve failed is that once it was used as targeting method, it altered inflationary expectations. Governments goosed demand in the hopes of lowering unemployment and ended up with high inflationary expectations and thus a shift upward in the curve. To squeeze inflation out of a system is hard since real interest rates are raised to a level consonant with high levels of unemployment to force the economy down to a lower Phillips Curve.

    Of course unemployment is a proxy for spare capacity and the inflation rate is a proxy for inflationary expectations. We do not understand spare capacity well – it changes with technology and with trade and with many other factors.

  10. I suppose that if you had a large reserve army in the labour force, and buggered about with the tax system, you could notionally alter the curve such that inflationary spending or demand could occur much higher up the income distribution. Or something.

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