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Lost in Extrapolation

Lost in Extrapolation

Phillips Curve Fail

In the late 1970s the impossible happened.  Inflation and unemployment simultaneously went vertical.  The leading economists of the day were flummoxed.

summersLarry Summers favors us with his “eternal stagnation” shrug. The man is a sheer inexhaustible fount of truly atrocious ideas. As we have previously pointed out, when he’s around, the economy can only be deemed safe under certain circumstances.
Photo credit: Reuters

The Phillips curve said there’s an inverse relationship between inflation and unemployment.  When unemployment goes down, inflation goes up.  Conversely, when unemployment goes up, inflation goes down.

Phillips_curveThese are the data economist William Phillips originally studied – wage rates vs. unemployment in the UK in the years 1913 to 1948. Phillips’ study will forever stand as a monument as to why economic theory cannot possibly be derived from empirical data. In the wake of the 1970s experience, at least seven Nobel prizes in economics were awarded for work that debunked the Phillips curve-based assumptions of the Keynesians in some shape or form. Recently its long dead cousin NAIRU has risen from the grave again, like a zombie – click to enlarge.

How could it be that both were going up at once?  Weren’t they mutually exclusive?  Indeed, it took years of heavy handed government intervention to pull off such a feat.

When unemployment began creeping up in the 1970’s the U.S. Treasury, with backing from the Federal Reserve, did what Keynes had told them to do.  They spent money to stimulate the economy and spur jobs creation.

According to the Phillips curve, with rising unemployment the planners could have their cake and eat it too.  They could run large deficits without inflation.

Unfortunately, something unexpected happened.  Instead of jobs they got inflation.  Then, when they tried it again, they still didn’t get jobs.  Astonishingly, they got more inflation.

Phillips Curve - evidence, shmevidence

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