December 15, 2019

Yes, There Is a Trade-Off Between Inflation and Unemployment

The Phillips curve helps explain how inflation and economic activity are related. At every moment, central bankers face a trade-off. They can stimulate production and employment at the cost of higher inflation. Or they can fight inflation at the cost of slower economic growth.

Soon after the Phillips curve entered the debate, economists started to realize that this trade-off was not stable. In 1968, Milton Friedman, the economist and author, suggested that expectations of inflation could shift the Phillips curve. Once people became accustomed to high inflation, wages and prices would keep rising, even without low unemployment. Soon after Mr. Friedman hypothesized a shifting Phillips curve, his prediction came to pass, as spending on the Vietnam War stoked inflationary pressures.

In the mid-1970s, the Phillips curve shifted again, this time in response to large increases in world oil prices engineered by the Organization of the Petroleum Exporting Countries — an example of a “supply shock” in economists’ parlance.

Today, most economists believe there is a trade-off between inflation and unemployment in the sense that actions taken by a central bank push these variables in opposite directions. As a corollary, they also believe there must be a minimum level of unemployment that the economy can sustain without inflation rising too high. But for various reasons, that level fluctuates and is difficult to determine.

Enter Representative Ocasio-Cortez. While questioning Jerome Powell, the Fed chair, during a congressional hearing in July, she suggested that the central bank’s understanding of inflation and unemployment was flawed.

“Do you think it is possible that the Fed’s estimates of the lowest sustainable estimates for the unemployment rate may have been too high?” Ms. Ocasio-Cortez asked.

“Absolutely,” Mr. Powell replied. The sustainable unemployment rate now appears to be “substantially lower than we thought.”

Article source: https://www.nytimes.com/2019/08/09/business/trade-inflation-unemployment-phillips.html?emc=rss&partner=rss

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