The Phillips splatter

The web has been full of Philips curve sarcasm and trolling recently, following comments from the Fed about the uncertainties in the relation between the output and unemployment gap and inflation.

But those not immersed in this should realise that the latest macro models used in central banks and outside – which have many other faults – do not hinge on such a simple bivariate relationship.  They all embody the view that both wages and prices are sticky.  And this is what gives monetary policy both its traction on real quantities, and the definition of its purpose.  And in turn, this stickiness is what gives real disequilibria their traction over inflation, in the short run.

But at any point in time we might expect there to be shocks moving around the natural rate of unemployment and the natural rate of output such that observed correlations between any two variables, like inflation and unemployment, were forever in motion themselves.

I recall that it was often tempting for central bankers to decide to simplify this muddled tale back in terms of old Philips Curve language.  But this is a hostage to fortune, since correlations inevitably move on.  When they do the false question ‘what do you do know your model has been blown out of the water?’ has to be answered.

This isn’t to say there are no genuine ponderables.  But they are not about Philips Curves any more.  They are about if prices are sticky [small vocal community of RBC like economists still making many deep and profound points on this score] or even whether stickiness really generates non-neutrality of monetary policy, and, of course, about the validity of the whole DSGE machinery.

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