The Phillips Curve

I've long had a little pictogram sitting in my cloud account, waiting for a rainy day and a chance to talk about the Phillips Curve. It's not sophisticated--just a simple matrix representing a thesis that twentieth century economics extrapolated from a graph plotted out by Bill Phillips which demonstrated an inverse correlation between the twin scourges of unemployment and inflation. The Relationship of Inverse Necessity (RIN)--which was not Bill Phillip's idea but is often attributed to him--states that an economy can only have low inflation or low unemployment but not both at the same ("Upside RIN"). Correlatively, society may suffer high unemployment or it may suffer high inflation but it won't have to endure both together ("Downside RIN"). Thus, stipulates the thesis, the possible outlier outcomes for inflation and unemployment in any given economy must lie in one of the orange boxes below.

Bill Phillips was a New Zealand economist who spent most of his academic career as a professor of economics at the London School of Economics. He was also an engineer, crocodile-hunter and internee at a prisoner of war camp. One of the most entertaining accounts of his career I have come across is set out in this short NPR podcast which, crucially, sets the record straight on the Phillips Curve. (Bill never claimed that the factual correlation he plotted out in 1958, to investigate an observation by Irving Fisher, reflected a necessary economic truth.)

The Upside RIN was debunked quite quickly by Milton Friedman who, in his 1968 Presidential Address to the American Economic Association, pointed out that the nature of the RIN was dependent on expected inflation and its being in a state of equilibrium with actual inflation. He argued that concerted efforts by the government to lower unemployment past that point of equilibrium would shift the whole curve to the right and create new expectations of wage inflation, in effect because workers would come to apprehend the promise latent in unrestrained government spending. This in turn would mean that the point to the left of the curve at which upticks in inflation are achieved for relatively small reductions in unemployment would occur much sooner (ie, earlier in the fight against unemployment, when it is relatively high).

A few years later, Friedman was largely vindicated when the economies of Western oil-consuming nations experienced some of the most rapid price inflation in their histories coupled with falling output and rising unemployment. Friedman's hypothesis was largely a warning about the limits of Keynesian economics, government spending and loose monetary policy--which undoubtedly played a part--but, as it turned out, exogenous supply-side shocks and cost-push inflation could be just as damaging to the Upside RIN thesis.

Even after the misery of stagflation, however, central banks clung to the Downside RIN as a staunch tenet of economic theory. That is, until the Great Financial Crisis and the discovery that there are circumstances of economic stress following which the jobs market can recover, with falling unemployment, without the economy necessarily seeing wage inflation or growth. For example, one of the less well anticipated features of the recession and recovery in the UK from 2009-2014 was that the demand for labour not only did not fall sharply along with output, but that it also recovered much more rapidly than output did, while wages remained depressed. Another feature was that, as the vacancy rate increased and unemployment fell in 2013-2014, so, too, did inflation. Elsewhere, while some European economies were able to observe a correlation, during the post-Crisis recession, between rising unemployment and falling inflation, this was not true by any means across the board.

The RIN Thesis has proved singularly difficult to dislodge as a tool of central bank decision-making, however... except that it has, in fact, long since been usurped by its own fictional siblings: marginal tolerance measures incorporated into monetary policy known as NAIRU (non-accelerating inflation rate of unemployment) and inflationary price stability. Here's an excellent article about all three and their interrelationship. The entire family of Phillips-related axioms is still living perfectly happily in the consciences of central bankers around the world and perhaps that's no bad thing. Better an honour system than no rules at all, as we librarians like to say.

Which brings us neatly to the April jobs numbers wherein it appears that book-keepers, researchers and professionals may actually have left the payroll last month, rather than joined it. Only about 25% of the anticipated new jobs were created, which came as a nasty shock to those who had predicted that the Bureau of Labour Statistics might report as many as one million new jobs.

Analysis of this phenomenon is not in short supply. Some pundits are pointing out that they warned long ago about the dangers of post-pandemic complacency; conservatives are grumbling that unemployment insurance has undermined everyone's Darwinian job-hunting instincts; progressives are asking why anyone would want to return to work when the wage floor has not increased since 2009; and others are quick to point out that childcare is still an issue until schools and nurseries are fully back in operation. One or two wise old hands are wondering whether monthly jobs figures aren't just an overreaction looking for somewhere to happen. I expect there's some merit in all these points but we should bear in mind that the pandemic has undoubtedly been the biggest psycho-social dislocation of our lifetimes. Whole populations learned to survive without a haircut or loo roll. Everyone got better acquainted with Amazon and less well acquainted with their barista. Social networks were dissolved and remade online. Kids adapted to life without birthdays, playgrounds or bullying. Twitter friends became our best friends and real friends became a distant memory. Babies were born out of "nothing better to do" and enforced celibacy became a tool of government. Parents became teachers, teachers became Audio Visual experts and Zoom virgins became awkward celebrities. Colleagues stepped up, dropped out, fell apart, manoeuvred round us or came through for us as usual but, whichever it was, we only found out about it by email after the event. Almost everyone now knows someone affected by a serious illness or a COVID death. For all the talk last month of "back to normal", it wouldn't surprise me at all if people were suddenly to find themselves reevaluating their lives and their priorities.

Furthermore, the Biden agenda, with its promise of "soft care" assistance in the infrastructure bill and help where it's most needed may be aimed at getting more people into paid employment in the medium- and long-term but it could be fostering a "wait and see" phenomenon in the short-term, while reforms are still in the pipeline. That overnight shift work that you were doing for a creepy boss because it was compatible with elder care? Well, maybe, just maybe, the light up ahead is the beckoning finger of a rosy new dawn.