Krugman on the Phillips curve
In a recent post I praised Steven Williamson for trashing the Phillips curve. Now Paul Krugman has a post defending the Phillips curve, which I am also going to praise. How can I agree with such diametrically opposed views? Simple, Williamson trashes the American version of the Phillips curve, the one using inflation and unemployment. As you may know I view inflation as an almost worthless concept, which does more to confuse than enlighten. In contrast Krugman discusses the original version of the Phillips curve. Well, not the actual original version, that was developed by Irving Fisher in 1923, but Phillip’s 1958 version, which used wage inflation instead of price inflation. Whereas price inflation is a useless concept, wage inflation is a highly useful concept, especially in business cycle analysis. Here’s Krugman:
Start with the raw data. Here’s unemployment and increases in nonsupervisory wages since 1985:
What you see is that wage growth was low when unemployment was high, and vice versa. Now take annual averages (to avoid overlapping data) and plot the unemployment rate against the wage change over the next year:
There are a couple of possible explanations for the return of the good old-fashioned Phillips curve: anchored inflation expectations, downward sticky nominal wages. I’ll have more thoughts on that later (actually, downward rigidity and anchored expectations I think reinforce each other). But the point is that notions of how inflation works that were formed in the era of stagflation are very much at odds with the way the world has looked, not just since the Great Recession began, but since the mid-1980s. Yet stagflation still shapes both public perceptions and policy.
Later in the post Krugman criticizes the natural rate hypothesis, which is where he loses me. I still think that’s a very useful concept, which explains why the US unemployment rate is falling despite stable (2%) wage inflation. But overall I’m thrilled to see that Krugman prefers the wage version of the PC, he’s far more influential than me.
PS. Notice that in 2009 wage inflation fell from 4% to 3%, whereas NGDP growth fell by 9 percentage points below trend. There’s your Great Recession, which had nothing to do with housing/banking/lack of fiscal stimulus etc., etc. Tight money and sticky wages create recessions. The Musical Chairs model.
PPS. Today the BEA raised the estimate of GDP growth once again. NGDP growth is running 4% in 2013 (NGDI at 3.9%). RGDP at 2.6%. I can’t wait to do my year end review; it’s been an incredible year for MM, in all sorts of ways.
PPPS. There is some interesting recent commentary over North Carolina’s reduced UI benefits (here and here). I’m waiting until we have more data before I chime in. I’m an agnostic on the issue, and don’t even know if state level results would carry over to the national level. In 2014 we may get a similar experiment at the national level.
Update: Kebko’s lastest update on North Carolina is fascinating.
PPPPS. Off topic, but file this under “It’s good to be the king.” King Obama has waved what the Supreme Court has ruled is a tax, for lots of Americans. What a nice Christmas present!