On October 24th, the New York Times published an article in its Upshot section titled, “The 57-Year-Old Chart That Is Dividing the Fed”, which discusses the Phillips Curve and its potential use by the Fed in considering raising interest rates.
An interesting article, but it was extremely shallow in content, and largely missed the underlying reason why the Phillips curve is, basically, useless in the current environment. As a refresher, the Phillips curve shows the relationship between inflation and employment, where lower unemployment leads to higher inflation, and vice-versa.
Generally, it makes sense. More people employed, wages rise, therefore costs rise, then prices rise and then you get inflation. The key factor in that equation is employment.
Quick Question: What is the quickest way to reduce the rate of unemployment?
Job Stimulus? No. Federal Deficits and Keynesian Spending? Nope. Tax Reform? No again.
The quickest way to reduce unemployment is to just stop counting the unemployed.
I know what you’re thinking – Very funny, but no one, especially our government, would just stop counting unemployed people….would they?
Yes, that’s exactly what the government does. If you are unemployed for more than a year you are no longer counted. Viola, lower unemployment.
Bringing this back to the Times article and the Phillips curve, the belief is that the 5% or stated unemployment rate could lead to inflation, and therefore rates should be increased.
However, with a material number of unemployed people not actually counted in the unemployed rate (with some suggesting that the actual unemployment rate is somewhere around 15 to 20%, or even higher), there is no point even looking at the Phillips curve because it has no bearing.
Relying on the Phillips curve in this situation is a bit like solely looking at the current plight of Volkswagon, and saying the entire automotive industry is having problems. Clearly, that doesn’t make any sense.
The reality is that the US is nowhere close to having low employment, but that’s not really the scary thing. The really scary thing is that the current levers being pulled by the Government aren’t really doing anything. We are running massive deficits, we have a Fed that has literally printed money and just given it out, and yet, the economy is not roaring back, nor do we have a material increase in new jobs.
Take a look at the Workforce Participation Rate. It’s been declining for the last few years, with it having peaked around 2001. So how can there be employment based inflationary pressure if the population has grown and workforce participation rate has declined? There isn’t employment based inflationary pressure.
My hunch, we are headed into an election cycle with the potential for a party change. Broadcasting that rates have to rise because of strong employment sure makes it seem like the administration is doing something right. The reality doesn’t support such a statement, but if t he media has taught us anything – if you keep saying the same thing over and over again, even if it’s not true, it can seem true.