What killed the Phillips Curve?
After Paul Volcker was appointed to run the US Federal Reserve by president Jimmy Carter, he had to wait until Ronald Reagan became president before he could tackle stagflation, the term that conjoined two components of economic reality, namely stubbornly high inflation and excessively high unemployment coupled with weak aggregate demand. According to Keynesian thinking, its conditions were thought not to occur because of the inverse relationship between inflation and unemployment.
Originating in 1958, the Phillips Curve was an iron-clad foundation stone of Keynesian economics. Because it predicted price and wage growth with profound accuracy, the belief that it was a law of economic thought remained unchallenged until Reagan was elected to beat stagflation.
Simply put, the Phillips Curve dictates an inverse relationship between unemployment and inflation. It only became a problem when it operated in different environmental conditions – social and political components that remained opaque until decades passed whereby younger economists could reconfirm antecedent work that predated John Maynard Keynes. The inverse component relations worked best in closed political economies with low debt. Given the profound changes wrought by Reagan’s defeat of stagflation, we can discern social, technological, political and institutional reasons to explain why the Phillips Curve broke down.
Just as banks are no longer the repositories for financing large multinational corporations, Reaganomics openly sought the defeat of rentier capitalist economics, chiefly through deregulation, by appealing to sound federalism. Philosophically, Reagan permitted the birth of new capital in the formation of new industries that reconfigured social dynamics. Having sought to promote liberty at the expense of welfare, he strengthened the spheres of autonomy that underwrite America’s social base. By untethering the bonds between government and the governed, he permitted new socio-political ratios that are not captured in Keynesian data.
Why is this significant?
It is important to remember the confusion that dominated professional economists throughout the administration of US president Barack Obama. Obama imposed secular stagnation as a panacea absolving technocrats of responsibility for imposed policy aims; cutting off any capability for the development of an advanced feedback loop into the execution of monetary policy, sundering any possibility of growth. Under Team Obama, the entire monetary establishment remained befuddled by the decoupling of employment from inflation.
The death of the Phillips Curve as a foundation stone for monetary thought unleashed new thinking to discover antecedent social components binding work to money creation, fortifying monetary institutions
In fact, the death of the Phillips Curve as a foundation stone for monetary thought unleashed new thinking to discover antecedent social components binding work to money creation, fortifying monetary institutions.
By examining Keynesian antecedents in civil society, monetary officials confirmed constitutive components of a political economy more social that positivist. Former Federal Reserve chairman Janet Yellen was forced to acknowledge the natural rate of unemployment (NAIRU, or non-accelerating inflation rate of unemployment) as distinct from government diktat. This isn’t an aggregate so much as a fundamental social reality. NAIRU embodies permanently opaque component relations of employment. It cannot be accurately measured because it is a social relation that isn’t commanded.
Second, obscurantist trends in Keynesian thought emboldened outsiders to find and confirm more antecedents that couldn’t be commanded by monetary reactionaries. Yellen’s confusing econo-talk meant that Austrians and other non-Keynesian types confirmed the reality of the natural rate of interest (r*).
For monetary economists to construct the federal funds rate, they seek the informing relation between the real interest rates and statistically known nominal inflation. This means when federal funds rates are above r*, money is tight and inflation should fall. The opposite also holds true. But here’s the ethical dilemma: no one knows the dividing line between the natural rate of interest and the federal funds rate because the informing components aren’t positivist trends that can be captured in data. The rise of digitization severed or increased Reagan’s spheres of autonomy that constitute civil society.
The most prominent factor constituting the natural rate of interest (r*) remains fiscal, an area of expertise Federal Reserve authorities ignore. We’re back to Reagan’s fortitude in Volcker (pictured below) to tightly tether fiscal and monetary policy in sequential execution. The Austrians and those from Chicago know a thing or two about reality outside government statistics.
Finally, a dead Phillips Curve orchestrated by Volcker reveals the absolute primacy of credibility, not independence. The win delivered by Team Reagan in the slaughter of stagflation and its consequence in a moribund Phillips Curve means that confidence in monetary officials remains paramount.
In a word, functioning institutions matter.