Is It Time For The Fed To Say Goodbye To The Phillips Curve Theory?

The U.S. economy is in a sweet spot, with unemployment at a near 50-year low and an inflation rate that's low and stable. But that combination — low unemployment and low inflation — has economists at the Fed wondering if a theory they've had about how the economy works is still relevant.

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By most accounts, Federal Reserve policymakers have been very successful in recent years. The evidence? Low inflation and extremely low unemployment. But the Fed's success has also undermined one of the basic theories it has relied on to understand the economy and how inflation and unemployment are related. It's called the Phillips curve. NPR's John Ydstie explains.

JOHN YDSTIE, BYLINE: For many years, the Phillips curve accurately predicted that when the unemployment rate was low, inflation heated up. But these days, jobs are very plentiful, yet inflation remains very low. That's got some people writing the obituary for the Phillips curve.

JAMES BULLARD: If you put it in a murder mystery framework - "Who Killed The Phillips Curve?" - it was the Fed that killed the Phillips curve.

YDSTIE: Some Federal Reserve humor from James Bullard, the president of the St. Louis Federal Reserve bank, who we spoke to about a week ago. And what was the murder weapon? Well, Bullard says, it was the Fed's long persistent focus on keeping inflation low and stable.

BULLARD: The Fed has been much more mindful about targeting inflation in the last 20 years. And because of that, we have lower inflation, more stable inflation. And so there isn't much of a relationship anymore between labor market performance and inflation.

YDSTIE: So, Bullard says, the Phillips curve isn't working. But rumors of its death may be exaggerated. It's certainly still invoked during the debates within the Fed about whether to raise interest rates. Some policymakers argue that, with unemployment so low right now, the Fed should be raising interest rates much more rapidly to head off inflation. Federal Reserve Chairman Jerome Powell is taking a gradual approach. Here he is earlier this month in an interview on the "PBS NewsHour."

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JUDY WOODRUFF: So you've repealed the Phillips curve?

JEROME POWELL: I wouldn't say it's dead. It might be resting.

YDSTIE: A little more central bank humor, this time an apparent reference to a classic Monty Python sketch. A man walks into a pet shop with what appears to be a dead parrot in a cage.

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JOHN CLEESE: (As Mr. Praline) I wish to complain about this parrot what I purchased not half an hour ago from this very boutique.

MICHAEL PALIN: (As Shop Owner) Oh, yes, the Norwegian blue - what's wrong with it?

CLEESE: (As Mr. Praline) I'll tell you what's wrong with it. It's dead. That's what's wrong with it.

(LAUGHTER)

PALIN: (As Shop Owner) No, no. It's resting. Look.

CLEESE: (As Mr. Praline) Look, matey. I know a dead parrot when I see one, and I'm looking at one right now.

(LAUGHTER)

PALIN: (As Shop Owner) No, no. It's not dead. It's resting.

CLEESE: (As Mr. Praline) Resting?

PALIN: (As Shop Owner) Yeah.

YDSTIE: The Phillips curve could just be resting. But with the help of a sleeping pill in the form of slow wage growth, says former Fed economist Ann Owen.

ANN OWEN: The traditional way in which low rates of unemployment lead to inflation is by increasing wages.

YDSTIE: And wage growth in the U.S. has been sluggish, which is part of the reason inflation is staying low. Whether the Phillips curve is dead or just resting, its long slumber has been useful for the Fed, says Owen, who is now a professor at Hamilton College. The U.S. economy's extended period of stable inflation and falling unemployment has allowed the Fed to raise interest rates gradually and to pause after every rate hike to see how the economy responds. Owen thinks Fed officials are fine with that situation.

OWEN: If you ask the Fed - do you want low and stable inflation, or do you want really rapid inflation because that would confirm your belief about how the economy works? - I have to believe that most of the people at the Fed would say, give me low and stable inflation.

YDSTIE: Even if it means the Phillips curve is dead.

John Ydstie, NPR News, Washington.

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