Is the Phillips Curve Still a Useful Guide for Policymakers?

Morgan Foy writes in the September 2019 issue of the NBER Digest on the question, Is the Phillips Curve Still a Useful Guide for Policymakers?

The Phillips curve, named for the New Zealand economist A.W. Phillips, who reported in the late 1950s that wages rose more rapidly when the unemployment rate was low, posits a trade-off between inflation and unemployment. When unemployment is low, and the labor market is tight, there is greater upward pressure on wages and, through labor costs, on prices.

The conceptual foundations of this relationship have been a subject of active debate, but for many decades, the relationship seemed well-supported by U.S. data. In the last two decades, however, the U.S. inflation rate has not been particularly high, even during periods of low unemployment. The recent data have led many to wonder whether the Phillips curve has weakened or disappeared. In Prospects for Inflation in a High Pressure Economy: Is the Phillips Curve Dead or Is It Just Hibernating? (NBER Working Paper No. 25792) Peter Hooper, Frederic S. Mishkin, and Amir Sufi examine why the Phillips curve relationship has not been evident in recent aggregate data for the United States.

The researchers study both inflation in consumer prices and inflation in wages. They test for a "price" Phillips curve using data on annual costs of goods and services, and for a "wage" Phillips curve using hourly earnings data. They allow for different relationships between inflation and unemployment in tight and in slack labor markets. Using a simple model that assumes a linear relationship between inflation and unemployment, and data from 1961 to 2018, they estimate that a one percentage point drop in the unemployment rate increased inflation by a mere 0.14 percentage points. However, when they allow for different effects of unemployment changes in tight and slack labor markets, they find that the estimated effect of a 1 percentage point unemployment decline on the inflation rate is about -0.32 percentage points when the unemployment rate is 1 percentage point below the natural rate, and -0.12 when it is 1 percentage point above it.

When examining data only from 1988 to 2018, the researchers see less evidence for a robust price Phillips curve. The linear and nonlinear slopes are both close to zero, consistent with the common view that the Phillips curve is flattening. However, the wage Phillips curve is much more resilient and is still quite evident in this time period.

The study points out that in the last three decades, the Great Recession notwithstanding, there has been less variability in the national economy than in prior decades, which makes it harder to detect the impact of unemployment on inflation. In addition, the Federal Reserve has tried to avoid labor market overheating as a way to stabilize inflation, thereby "anchoring" inflation expectations at a 2 percent inflation level and reducing the effect of unemployment fluctuations on price movements.

The researchers observe that state- and city-level data provide more variability in unemployment rates and are less influenced by federal monetary policy than the national figures. Therefore, they explore the relationship between unemployment and inflation at this level. They find a strong negative relationship between the unemployment rate's deviation from the state average and the rate of wage inflation. They also find evidence of a nonlinear price Phillips curve in city-level data.

The researchers point out that the relationship between inflation and the unemployment rate is a key input to the design of monetary policy. They note that the unemployment rate in the U.S. economy is currently near record lows, and they caution that they cannot predict whether inflation will rise in the coming years. However, they conclude that "Evidence that the price Phillips curve has been dormant for the past several decades does not necessarily mean that it is dead... it could be hibernating, and there is a risk of the Phillips curve waking up, with inflationary pressures rising in the face of an overheating labor market."

Normative versus positive analysis in the history of the theory of production

This paper looks at the history of the theory of production. Before the seventieth century, with the advent of mercantilism, the predominant mode of enquiry was a descriptive/ normative one. The frameworks applied were ethical and/or religious. The questions asked were about what production or occupations would find favour with God or what production was ethically justified. The important point is that these normative frameworks did not give rise to a theory of production. Such a theory only began to emerge with the emergence of a positive approach to economic reasoning more generally.

Normative versus positive analysis in the history of the theory of production by Paul Walker on Scribd

Should we assess our economy through trendy 'wellbeing' metrics?

GDP, or Gross Domestic Product, a strange statistic in modern political debate. Economists point out that it fails to capture the value of an increasingly digital economy but it remains the measure most politicians and journalists pay attention to. According to GDP, if a mother decides to go out to work as a childminder and pay a childminder to look after her own child, rather than look after the child herself, that is increased GDP, despite the fact the same number of children are being looked after the same number of people. So, should we be looking to alternative measures, perhaps ones which measure a country’s social and economic performance more holistically? Recently New Zealand’s Prime Minister Jacinda Ardern has backed a ‘different approach for government decision-making altogether.’ “We are not just relying on Gross Domestic Product, but also how we are improving the wellbeing of our people,” said her Finance Minister. Joining the IEA’s Digital Manager Darren Grimes to discuss the best ways to measure a country’s economic performance is the IEA’s Senior Academic Fellow, Professor Philip Booth.

Who pays for the minimum wage?

This question is asked in a new article, Who Pays for the Minimum Wage?, in the latest issue (Vol. 109, No. 8, August 2019) of the American Economic Review.

The paper is by Peter Harasztosi and Attila Lindner and looks at the margins along which firms responded to a large and persistent minimum wage increase in Hungary. It finds that the employment elasticities are small, but negative.

The abstract reads,

This paper provides a comprehensive assessment of the margins along which firms responded to a large and persistent minimum wage increase in Hungary. We show that employment elasticities are negative but small even four years after the reform; that around 75 percent of the minimum wage increase was paid by consumers and 25 percent by firm owners; that firms responded to the minimum wage by substituting labor with capital; and that disemployment effects were greater in industries where passing the wage costs to consumers is more difficult. We estimate a model with monopolistic competition to explain these findings.

Bad economic justifications for minimum wage hikes

Ryan Bourne has authored a recent paper at the Cato Institute on Bad Economic Justifications for Minimum Wage Hikes.

The bad reasons he gives are,

• A solution to a market failure?
• To keep pace with productivity trends?
• Costs of living
• Poverty

His conclusion reads,

The metrics that $15 minimum wage advocates use to make the case for substantial minimum wage hikes are not, on their own, economically sensible benchmarks by which to set minimum wage rates.

Economy-wide productivity growth can be a poor guide to productivity trends for minimum wage workers and different localities, and it tells us little about whether firms have the power to set below-market wage levels.

Housing and childcare costs are unrelated to firms’ ability to pay or the value of the work minimum wage employees undertake. And comparing the income of someone working full-time at the federal minimum wage to existing poverty thresholds ignores the role of anti-poverty programs and the fact that many minimum wage earners are not poor.

Campaigners’ arguments often imply that minimum wages should be linked to productivity measures, living costs, or poverty thresholds. The evidence presented above suggests that translating these arguments into policy could produce damaging labor market outcomes.

Bernie Sanders and bad justifications for minimum wage hikes

This audio is from the Cato Daily Podcast.

The tiff between workers for the Bernie Sanders campaign and the campaign leadership illustrates some of the tradeoffs inherent in mandating wage floors. Ryan Bourne is author of a new paper on minimum wage hikes and bad justifications for them.

The Conservative Sensibility

Caleb O. Brown interview George F. Will about his new book The Conservative Sensibility

Rights precede government. That’s the core of the American founding, and George F. Will argues that it’s worth preserving. His new book is The Conservative Sensibility.

Making Sense of the minimum wage

Recently the Cato Institute put out a new Policy Analysis (No. 867) on Making Sense of the Minimum Wage: A Roadmap for Navigating Recent Research by Jeffrey Clemens. Clemens is an associate professor of economics at the University of California, San Diego.

Executive Summary:

The new conventional wisdom holds that a large increase in the minimum wage would be desirable policy. Advocates for this policy dismiss the traditional concern that such an increase would lower employment for many of the low-skilled workers that the increase is intended to help. Recent economic research, they claim, demonstrates that the disemployment effects of increasing minimum wages are small or nonexistent, while there are large social benefits to raising the wage floor.

This policy analysis discusses four ways in which the case for large minimum wage increases is either mistaken or overstated.

First, the new conventional wisdom misreads the totality of recent evidence for the negative effects of minimum wages. Several strands of research arrive regularly at the conclusion that high minimum wages reduce opportunities for disadvantaged individuals.

Second, the theoretical basis for minimum wage advocates’ claims is far more limited than they seem to realize. Advocates offer rationales for why current wage rates might be suppressed relative to their competitive market values. These arguments are reasonable to a point, but they are a weak basis for making claims about the effects of large minimum wage increases.

Third, economists’ empirical methods have blind spots. Notably, firms’ responses to minimum wage changes can occur in nuanced ways. I discuss why economists’ methods will predictably fail to capture firms’ responses in their totality.

Finally, the details of employees’ schedules, perks, fringe benefits, and the organization of the workplace are central to firms’ management of both their costs and productivity. Yet data on many aspects of workers’ relationships with their employers are incomplete, if not entirely lacking. Consequently, empirical evidence will tend to understate the minimum wage’s negative effects and overstate its benefits.

Tyler Cowen interviews Russ Roberts

What are the virtues of forgiveness? Are we subject to being manipulated by data? Why do people struggle with prayer? What really motivates us? How has the volunteer army system changed the incentives for war? These are just some of the questions that keep Russ Roberts going as he constantly analyzes the world and revisits his own biases through thirteen years of conversations on EconTalk.

Russ made his way to the Mercatus studio to talk with Tyler about these ideas and more. The pair examines where classical liberalism has gone wrong, if dropping out of college is overrated, and what people are missing from the Bible. Tyler questions Russ on Hayek, behavioral economics, and his favorite EconTalk conversation. Ever the host, Russ also throws in a couple questions to Tyler.