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Like what "is" is, it depends on what "only" means [1]

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Date: 2023-07-15  

Has moral suasion taken a holiday. This likely will not explain where the economy is.

(July 10, 2023) Since January 2021, the 12-month core PCE inflation rate increased to a 40-year high, while the unemployment-to-vacancy ratio declined to a 50-year low. A low value of this ratio indicates a very tight labor market, making it increasingly difficult for employers to find and hire workers, thereby putting upward pressure on wages and prices. In this Letter, we estimate nonlinear Beveridge and Phillips curves that share key underlying characteristics and can account for elevated inflation readings over the past two years. Our estimates imply that, starting from current labor market conditions, the FOMC’s desired goal of a soft landing for the economy is achievable if a decline in inflation to near 2% is accompanied by a reduction in labor market tightness arising mostly from a sizable drop in job vacancies with only a modest increase in unemployment. www.frbsf.org/...

(2018) It seems unlikely that the Fed will get a definitive resolution to the Philips Curve puzzle, given that the debate has been raging since the 1990s. How the Fed responds to the uncertainty, however, will have far reaching implications for monetary policy and the economy. www.brookings.edu/… (2020) Perhaps equally important and interesting is that the monetary policy implications (justified by the Keynesian models that use the Phillips curve) are not obvious, based on the phase spectrum. The conventional wisdom is that a negative correlation between inflation and unemployment automatically implies a trade-off between the two and a causal link running from inflation to unemployment. But the phase spectrum shows that in the long run, high inflation tends to "cause" high unemployment instead of low unemployment, and in the intermediate run high inflation tends to follow (instead of lead) low unemployment. Therefore, it is not clear how monetary policy that directly affects inflation could affect unemployment during the business cycle despite the strong evidence of a negatively sloped Phillips curve at the business cycle frequency. Abstract A.W. Phillips's discovery that inflation is negatively correlated with unemployment served as a heuristic model for conducting monetary policy; but the flattening of the Phillips curve post-1970 has divided debate on this empirical relation into two camps: "The Phillips curve is alive and well," and "The Phillips curve is dead." However, this dichotomy oversimplifies the issue. In this article, we apply spectral analysis to the U.S. inflation rate and unemployment rate to conduct a comprehensive analysis of the Phillips curve in the frequency domain. We find that in the very short run, there is no systemic relationship between inflation and unemployment; in the intermediate run, which includes the business cycle frequency, they are strongly negatively correlated; and in the very long run the Phillips curve is strongly positively sloped. Such an analysis of the frequency domain provides a natural demarcation of frequency bands that allows us to recover the Phillips curve in the time domain by applying band-pass filters. Most importantly, we show how spectral analysis can be used to identify a "supply" (permanent) and a "demand" (nonpermanent) shock in the context of a vector autoregression and that demand shocks drive the Phillips curve. Finally, the phase spectral analysis also shows that despite the existence of the Phillips curve at the business cycle frequency under a demand shock, the monetary policy implications are not obvious, due to the unclear lead-lag relationship between inflation and unemployment. research.stlouisfed.org/...

The Phillips curve is an economic theory that inflation and unemployment have a stable and inverse relationship. Developed by William Phillips, it claims that with economic growth comes inflation, which in turn should lead to more jobs and less unemployment. The original concept of the Phillips curve has been somewhat disproven due to the occurrence of stagflation in the 1970s, when there were high levels of both inflation and unemployment.12 www.cato.org/...

x They now have in hand evidence of a slowing labor market, a decline in goods prices excluding food and energy, and strong evidence of declining shelter inflation on the horizon, said @WendyEdelberg.



Via @CNN & @BuchElisabeth: https://t.co/H7N04GVLBI — Brookings Econ (@BrookingsEcon) July 14, 2023

Jerome Powell repeatedly stresses that the Fed takes a data-dependent approach to interest rate decisions. “They now have in hand evidence of a slowing labor market, a decline in goods prices excluding food and energy, roughly unchanged prices in an important category of services, and strong evidence of declining shelter inflation on the horizon,” said Wendy Edelberg, director of the Hamilton Project at the Brookings Institution. “I think an excellent case can be made for again standing pat at the next meeting,” she told CNN. Fed officials, however, have signaled they’re likely to raise rates by a quarter point at its next meeting. But the looming question is what the Fed should do for the rest of the year. In Schoenholtz’s view, the Fed should continue to hike interest rates even though inflation slowed down sharply in June despite the central bank holding rates steady. The Fed needs people to believe it means business when it comes to its 2% target, he said. Otherwise, people will expect higher levels of inflation and businesses will continue to set prices accordingly. If the Fed waits too long to raise interest rates, it could risk its credibility, leading to a persistently higher price level that’s harder for the Fed to crack down on. The central bank’s aggressive rate hikes are getting prices to stabilize, he added. “[Fed officials] do not want to sacrifice what they’ve gained.” www.cnn.com/...

This was most apparent in Joan Robinson’s discussion of the labor market, which hinged on an explicit wage-push theory of inflation, since “a constant upward pressure upon money wages is exercised by workers (the more strongly the better they are organised) and a constant downward pressure by employers, the level of wages moving up or down as one or the other party gains an advantage.” She came very close to anticipating the Phillips curve, according to which there is an inverse relationship between unemployment rates and wage increases in an economy, noting that “the existence of unemployment weakens the position of the Trade Unions by reducing their financial resources and awakening the fear of competition from non-union labour.” This led Robinson to redefine full employment, rejecting Keynes’s convoluted discussion in the General Theory in favor of a much simpler definition: “the point of full employment” was simply “the point at which every impediment on the side of labour to a rise in money wages finally gives way.” There were important policy implications to this argument. If the level of money wages determined the price level — which set the rate of interest via the transactions demand for money — and hence determined investment, effective demand, and employment, then trade unions had considerable economic power: The control of policy is, in a certain sense, divided between the Trade Unions and the monetary authorities, for, with given monetary conditions the level of the rate of interest is largely determined by the level of money wages. A sufficient rise in money wages will always lead to a rise in the rate of interest and so check an increase in employment. This was sufficient, Robinson maintained, to discredit the quantity theory of money (later revived by monetarist economists such as Milton Friedman). It also posed real difficulties for any government committed to the goal of full employment, since without central control over money wage increases, there was a real risk that high levels of employment would induce accelerating inflation. jacobin.com/...

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