The Phillips curve seemed remarkably stable in a century of UK labor market data. But as soon as Phillips published his eponymous article, it vanished. That didn't stop economists from seizing on the Phillips curve as a building block of macro theory to prop up the neoclassical synthesis; Samuelson's attempt to connect Keynesian economics with classical ideas.
Why is this relevant? Because central bankers think that by lowering interest raters even further they will create inflation. This is a bad mistake. We need to raise rates now and support the value of risky assets by trading an ETF in the stock market.
Much more to come in my forthcoming book "Prosperity for All", coming in September from Oxford University Press.
There is a very simple reason why raising the Fed Funds Rate from very low levels increases inflation. Very low interest rates favour the financial sector because it makes leverage very cheap. Higher interest rates move money from the financial sector to the real economy and therefore raises inflation.
ReplyDeleteIf you look at the three graphs on http://www.philipji.com/item/2016-03-10/does-raising-the-fed-funds-rate-raise-inflation you can see the effect.
Thanks Philip. Interesting charts. I'm certain of only one thing: the mechanism by which lowering interest rates is supposed to lead to higher inflation, according to standard theory, is certainly wrong.
DeleteThe book is sure to be a good read. Also, and maybe channeling Scott Sumner a bit, but wouldn't it matter *how* the CB raises interest rates if it is to stoke inflation?
ReplyDeleteThanks Dustin. The main decision in operationalizing a rate rise is whether the Fed continues to pay interest on reserves. There are also important exchange rate implications. A rate rise will increase the value of the dollar and dissipate the effects of any accompanying QualE policy to the rest of the world.
DeleteThis comment has been removed by the author.
ReplyDeleteFunny, before seeing this post, having not visited your blog for a few months, I first read, http://rogerfarmerblog.blogspot.com/2015/10/demand-creates-its-own-supply.html#more .
ReplyDeletePerhaps you know where this is going: not only is the Phillips Curve probably nonexistent as a macroeconomic phenomenon, but perhaps also the Fisher Relation (interest rates ~ inflation), underlying your suggestion.
As a student, I observed that basically to attack unions, the Phillips Curve promulgators seized on a few instances of wage-driven inflation in the 60's and 70's, mainly in Europe, to build their econometrics. Detections since then are uncertain, reflecting the sporadic existence of the underlying wage-price-volume processes. On the micro level, most of the work I've seen shows rising minimum wages ineffective at reducing demand, so say no more.
It is hard to see how an increase of interest rates fits with the analysis of your October post where investment reflects expected demand. My suspicion is that investment these days is slow because of uncertainties in future demand; and these, primarily due to the stranglehold on social investment, a mandatory inclusion in aggregate "I." My hypothesis is that the recent "slump" in productivity is driven by the accumulating impact of inadequate infrastructural investment, of all types, from transport to teachers, that have been blocked in congresses, parliaments, assemblies, even general committees, everywhere.
So, to conclude on a Keynesian note, it makes little sense to increase the marginal cost of capital above the marginal efficiency of capital in hopes of increasing investments. Quite the contrary, the central bank network should keep its heads down until positive interest rates are actually warranted.