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.