Low Unemployment Can Drive Inflation Says The Phillips Curve : The Indicator from Planet Money For decades, policymakers chose to put millions of people into either a frying pan (inflation) or a fire (unemployment). An idea called the Phillips Curve was influential. But is it still?

Inflation, Unemployment And The Phillips Curve

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This is THE INDICATOR FROM PLANET MONEY. I'm Stacey Vanek Smith.


And I'm Darian Woods. So, Stacey, last night in his speech to Congress, President Biden announced his full 10-year economic plan. It's a proposal for $4 trillion of spending on everything from electric car subsidies to two years free community college. And that's on top of all the trillions of extra government spending during the pandemic recession over the last year. It's a lot of money.

VANEK SMITH: I have to say, Darian, I do always get a little bit of an uneasiness when I hear about all this government spending. Like, I always worry a little bit that there is like a catch, like the other shoe is going to drop somewhere.

WOODS: And one thing that the more nervous economic commentators out there worry about is inflation.

VANEK SMITH: Yes. So price inflation - basically just prices going up - that is one of the big threats that comes up in these debates about government spending. And the worry isn't about prices rising a little bit or just rising here and there. There's a worry about runaway inflation. That is widespread prices rising really fast, far above where they normally are.

WOODS: And, Stacey, there's this concept that economists use to think about the connection between inflation and unemployment, two indicators that are pretty heavily influenced by government spending. It's called the Phillips curve.

VANEK SMITH: The Phillips curve.

WOODS: That's right. It's one of the more famous curves in macroeconomics.

VANEK SMITH: Of the curves. It's like the Kardashian of curves, you could say.

WOODS: That's right. Maybe not for everyday people. I mean, I'd certainly never heard of it before studying economics. But it's kind of econ famous. And the Phillips curve is pretty helpful to understand the current debate about whether we need to worry about inflation.

VANEK SMITH: So, today on THE INDICATOR, we are going to introduce you to the crafty kiwi the Phillips curve is named after.

WOODS: And we're also going to check the pulse on the Phillips curve. Sixty years on, is the Phillips curve dead?

VANEK SMITH: Do you consider yourself a crafty Kiwi?

WOODS: Oh, yeah.


WOODS: The Phillips curve is this really important economic relationship between unemployment and inflation. And it's named after my favorite economist of all time. And I'm quite biased here, Stacey.

VANEK SMITH: Right, 'cause...

WOODS: He's a kiwi like me.

VANEK SMITH: And you guys stick together, right?

WOODS: We stick together.

VANEK SMITH: New Zealand economist types.

WOODS: Yeah. There's only three of us.


WOODS: But don't just take my word for it. Tim Harford wrote about Bill Phillips in his book, "The Undercover Economist Strikes Back." And here he is rattling off Bill's resume.

TIM HARFORD: He worked as a gold miner, as a crocodile hunter. He was accused of spying in the Second World War. He built improvised machine gun tripods.

VANEK SMITH: OK. So, Darian, this is like the most exciting economist I've ever heard about in my life. He sounds like G.I. Joe.

WOODS: He was actually an engineer in World War II working for the Air Force.

HARFORD: He tried to cross from Indonesia to Australia in a boat made out of an upturned shell of an abandoned bus. He built a secret miniature radio inside the heel of his shoe in a POW camp. He'd have been executed if it'd been found. Here's the Indiana Jones of economics.

VANEK SMITH: Bill Phillips' resourcefulness was put to use when, after the war, he signed up to attend the London School of Economics.

HARFORD: He also, by the way, published what I think is still the most cited paper ever in macroeconomics.

WOODS: And that's because in 1958, Bill Phillips got his hands on all this wage and price data in the U.K. going back to 1861. And over the weekend, he just plotted it out by hand, making a bunch of charts throughout the decades that were pretty simple, actually. He plotted wage increases on the vertical axis, unemployment on the horizontal axis. And it was this really clear downward curve.

VANEK SMITH: And Bill Phillips did not call it this, but he had just found the Phillips curve. And what this showed along the X and Y axis was that you had these years of high wage growth and low unemployment. And at the other end of the curve, you had years of high unemployment, but low wage growth, almost like there was this trade-off. Like, yeah, you can create more jobs, but there will be a price to pay, like literally a price to pay because prices will go up if more people have jobs.

WOODS: And there was a seismic shift in the way governments thought about the economy. A lot of policymakers saw this and thought, wow, the world is kind of cruel. Like, you can pick your poison almost. As a government, you can choose to spend a lot of money, hopefully create a lot of jobs, get low unemployment, but then you'll have high inflation. All goods can be cheaper, but fewer people can have jobs to even afford those goods.

VANEK SMITH: Of course, Darian, like most big ideas in economics, there was a lot of debate. But there was also this kind of general acceptance, you know, to get prices under control, you had to at least temporarily have a chunk of the population out of work.

WOODS: Until the Great Recession. The Great Recession in 2008 pushed unemployment up really high. And as the government started pumping more money into the economy to bring back jobs, unemployment started to drop. And we heard from some people that rising inflation would now be a real worry. But at this time, the inflation rate was barely making a peep.

VANEK SMITH: And a lot of people were just waiting for the other shoe to drop. But over the next few years, unemployment kept dropping very steadily all the way down to 3.5% in early 2020.

WOODS: And inflation was still really low. The inflation rises that people were worrying about never appeared. So if you look at the Phillips curve now, it is much weaker. The relationship between unemployment and inflation in places like the U.S. doesn't seem to be holding as much.

RUPAL KAMDAR: I've heard a lot of terms about the Phillips curve, you know, dead, alive, sleeping, hibernating.

VANEK SMITH: This is Rupal Kamdar. She's an assistant professor at Indiana University. And she says there are potentially a few reasons for this. But the big one is just that the Federal Reserve has been doing one of its jobs really well, which is keeping price increases low at around 2%. Almost everyone now just expects inflation to stay at roughly 2% a year. And that in and of itself can make it happen. It like manifests like a self-reinforcing circle. So when Bill Phillips first saw the Phillips curve, this relationship between unemployment and price increases was very strong. It made a very robust little curve.

But now central banks act in a way that makes it harder to find that relationship. So this Phillips curve gives us this way to think about the current debate around government spending. Now, we know there is a relationship between unemployment and inflation, but it just seems to be a lot weaker than it was in the past. And that terrible dilemma, like you have to choose unemployment or prices going out of control, it doesn't appear to be as much of a free choice anymore. Like, we could choose to have low unemployment and low inflation, the yes-and economy.

WOODS: But some economists say that's too simple. They are worried that central banks and the government could start to lose all that credibility that they've built up over the years keeping inflation low. Prices might start to rise as the economy overheats. The government won't be able to keep up. And we could get runaway inflation. But Rupal sides with another group of economists who have a different view.

KAMDAR: I believe the prospect of runaway inflation to be extremely unlikely. We are well below and far away from the economy being at a level where it's running too high.

WOODS: She says that the number of jobs lost since the start of the pandemic are just so high. More than 1 in 20 jobs have vanished. And there is one caveat. There may come a point where we get so many jobs it pushes up prices everywhere. The Phillips curve, while weak, still does exist sixty years after that paper was written.

KAMDAR: He wrote that Phillips curve paper that has had such staying power over a weekend in 1958. Like, it was like such a - what he thought small contribution. And here we are in 2021 still talking about this thing.


WOODS: I could talk about Bill Phillips all day, Stacey, but I'm going to stop here.

VANEK SMITH: Well, you know, for people who are finding that maybe slightly crushing or disappointing right now, they should take heart because on Friday, we have our Indicator of the Week. And we will do a deep dive into inflation in the pandemic economy. There will be catch-up.

WOODS: Or there won't be catch-up. That's the whole problem at the heart of tomorrow's episode.


VANEK SMITH: This show was produced by Dave Blanchard with engineering by Gilly Moon. It was edited by Kate Concannon. And THE INDICATOR is a production of NPR News.

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