Trump’s top economic adviser has ditched the Phillips curve—and it’s not crazy

“I hope the Fed understands.”
“I hope the Fed understands.”
Image: Reuters/Kevin Lamarque
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In the world of economics, even fleetingly thinking that “this time is different” is considered sacrilegious. It almost never is (paywall).

For Larry Kudlow, top economic adviser to Donald Trump, to argue that jobs can continue to grow without high inflation could seem more than a little foolish. That didn’t stop the head of the National Economic Council from telling Fox Business Network he hopes the US Federal Reserve knows “more people working and faster economic growth do not cause inflation.” Kudlow then repeated his point. They “do not cause inflation.”

There are few things more fundamental to traditional economic theory than the idea that there is an inverse relationship between inflation and unemployment: When more people have jobs, more money is available to be spent. And that, in theory, drives up prices. This is known as the Phillips curve.

Still, the logic behind Kudlow’s statements isn’t that crazy.

For decades, the world’s central bankers have almost lived and died by the Phillips curve, and it predicted inflation and wage growth reasonably well until the 1980s. Since then, however, the relationship between the factors it is meant to predict has been more complicated. As long-term wage growth has slowed in many countries, some think it will take a while for it to affect inflation in a broad sense.

Policymakers and markets continue to obsess over inflation rates and interest-rate hikes. Yet even former Federal Reserve chair Janet Yellen has gotten skeptical: How US inflation remained low in 2017 despite strong jobs growth was a “mystery” to her (paywall). In 2016, she called for a new analysis of inflation dynamics (paywall).

On June 25, a Bank of Japan board member decided to remind everyone that the Phillips curve doesn’t work in Japan.

Some economists argue (paywall) that the ways in which we measure the variables at play, like wage growth, unemployment and inflation, need to change—not the underlying theory. But questioning the theory—and perhaps arguing against it—is no longer an arrestable offense.

Maybe this time really is different.