Will inflation really snap back once “temporary factors” abate?

December 14th, 2015 at 6:10 pm

In a post this morning, I noted the Fed’s theory of the case as to why inflation isn’t accelerating in response to the tighter job market: temporary factors, including low, low oil prices and the strong dollar, are blocking the usual signal.

While it’s certainly the case that pricier oil and a weaker dollar would be inflationary, there are reasons to doubt the Fed’s explanation. First, it’s not just that inflation isn’t picking up as output gaps close and unemployment falls. Inflation didn’t fall as much as expected when such activity gaps were much wider.

Second, there’s this figure from a recent paper by Blanchard, Cerutti, and Summers (BCS), showing that a flat slope of the Phillips curve (PC) across a bunch of economies ain’t exactly a new development (the PC measures the correlation between labor market slack and inflation). By this measure, the slope of the PC has been low for a decade. BCS show that the US coefficient is now about 0.2, well below its historical levels in the 70s and 80s, and not statistically significant (from what I can tell–see Figure 9). The German PC slope is 0 and insignificant.

Source: Blanchard, Cerutti, Summers.

Source: Blanchard, Cerutti, Summers.

As you can see, these estimates allow the PC slope to change over time. Do more traditional approaches yield different results? In the same paper, BCS provide such results by country (Table 6). Many slope coefficients are insignificant  (at the 0.05 level or below), including the US using the more recent sample (2007-14).

To be fair, Larry Ball, in commenting on BCS, runs particularly transparent models and finds more stable, significant PC coefficients (though they are of the same magnitude as BCS) . He argues, as he has in earlier papers, that “the biggest change in the Phillips curve is the anchoring of expectations, and that makes it easier to stabilize inflation. If a shock pushes inflation up, anchored expectations push it back down without the need for a monetary tightening and higher unemployment.”

These distinctions, however, do not give much support to the view that the flat PC is temporarily low as a function of a few unique factors. Whether it’s anchored expectations, globalization, demographics, or the other factors I cited in my earlier post, recent PC dynamics suggest that monetary policy can safely accommodate low unemployment without a lot of angst about price pressures.

Inflation hawks, pull in your talons!

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6 comments in reply to "Will inflation really snap back once “temporary factors” abate?"

  1. Ben Groves says:

    CPI inflation has already snapped back

  2. Smith says:

    You can either have a world of rising inequality, where wages trail inflation, and a combination of unemployment, globalization, insourcing, outsourcing, exploitation of high and low skills immigrant labor, manipulation of the now outdated Fair Labor Standards Act, continued after-effects of Taft-Hartley and decline of organized labor and factory work, the decline of physical labor, high living standards even of the struggling middle class and working poor enrich the 1%,
    You can fight back. If you want higher wages due to low unemployment AND low inflation, you have change the game being played. The only way to keep prices down is for government policy to take away incentives the 1% currently has to grab up all the toys. When confiscatory Eisenhower marginal rates of 90% are imposed on earnings above $2 million, then at least there is a chance the titans of industry might allow workers a raise without threatening to raise prices and begin a spiral. There are plenty of other measures available to fight price increases, but the most important one is to take away the great benefits that price increases bring.

    The very vocabulary of Phillips Curve, NAIRU, and Taylor should be banished to the dustbin of history. Those centrists and Clinton like New Democrats who promote free market liberalism, rising tides, and win win meritocracy run government are kidding themselves. That’s ignoring the actual self interest of politicians who sacrifice the middle class for the safety of incumbency. Tax the idle rich, the corporations, break up the banks, and reign in Wall Street. If prices still rise, threaten control or nationalization, that will stop them cold in their tracks. Provide a public option if necessary. Just don’t replace the tyranny of the 1% with an unresponsive bureaucracy. Lower prices by fiat if necessary. Start with my cable bill.

  3. Smith says:

    Taxes on foreign earnings may seem peripheral to the discussion about inflation, but it’s not. The so called compromise being worked on by Democrats to lower rates and encourage repatriation of overseas profits would be a huge error. Instead of encouraging U.S. businesses to bring earnings home to invest here, it would do the opposite. Companies would stand more to gain from foreign investment in factories where labor is cheaper since they could then collect the profits earned from overseas operations with a lower penalty. The money and benefits would go to the 1%, the labor market would be further weakened. Not recognized all the many ways labor is weakened leaves economists to shake their heads in wonder why inflation expectations remain low. It also leaves them unprepared for a world in which labor power was resurgent. Inflation would spiral without a proper and innovative response.

  4. Nick Buffie says:

    Hi Jared,

    This may or may not contribute to answering your question, but I thought I’d pass you a paper I recently did on how the U-3 unemployment rate is out of line with all of the alternative unemployment rates. The idea here is basically that the U-3 rate is understating the level of slack in the labor market because all eleven alternative measures are identifying a greater level of slack: http://cepr.net/publications/reports/the-anomaly-of-u-3-why-the-unemployment-rate-is-overstating-the-strength-of-today-s-labor-market

    Arguably part of the reason for the breakdown of the Phillips Curve over the past few years is not that we need even less slack before we see accelerating inflation, but instead that the U-3 rate itself is simply mis-measuring slack.

    Also, as an aside, I originally got the idea for that paper after reading this piece of yours in the WaPo: https://www.washingtonpost.com/posteverything/wp/2015/02/24/the-curious-incident-of-the-wage-and-price-data-not-barking-in-the-night/ Obviously, the conclusions I reached in my paper very much support your argument from that op-ed.


    Nick Buffie
    Center for Economic and Policy Research