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Tuesday, August 30, 2011

Is the Phillips Curve Valid?

In comments Art points me to this post by Noah.  I was familiar with it, because Noah is one of my favorite bloggers (see the right sidebar.)   Noah illustrates the shifting nature of the Phillips curve over time.  This made me wonder if it really is a valid way to look at the data.  I replotted the 1966 to 1981 CPI and unemployment data from my Not the 70's post, Phillips style, and looked askance at it.  Notice how Noah assigns the data points to the various curves: '75 with '80 and '81; '82  and the early 90's with the early 70's;  later 90's with the late 60's.  So the shifting seems a bit capricious.  Or maybe I'm just disorientated by the time travel.

This Philippianism strikes me as forcing the data into preconceived packets, not letting the data drive a conclusion.

My quasi-Phillipian chart has Excel-generated best fit lines through the same monthly data I plotted earlier, grouped by time, more or less per Noah's groupings.  The difference is that I kept '75, frex, in the same group as '74 and '76, rather than inexplicably plop it out with '80 and '81.  My groups are 1966-69 (pink), 1970-73 (yellow), 1974-79 (red), and 1980-81 (purple).  Note that each later time packet is farther to the right and higher.  I've also added a best fit line (blue) for the entire 1966-81 data set.  Except for the 1966-69 set, the R^2 values are pretty ho-hum, and the straight blue line, which illustrates inflation and unemployment rising together - and thus totally contrary to Phillipian thinking - is only slightly worse than the others, and actually quite a bit better than the red data set.




My point here isn't to try to disprove the Phillips curve.  It's to illustrate yet again that the late golden age period, characterized by unusually high inflation, is different from other times before or since.

Art also asks why the peaks were increasing with time in the earlier graph - an observation you can also make here.  This might be kicking the can, but I'll say they increased because underlying inflation was increasing.  The post-WW II period up through about 1980 was a time of secular inflation.   Other effects were superimposed on a rising baseline, and that might confound cause and effect relationships.   Since then, we've had disinflation, and are now at the edge of actual deflation.

Near as I can tell, nobody understands that, either.
.





6 comments:

Stagflationary Mark said...

This was my attempt last year.

The Failed Keynesian Phillips Curve

If the Fed's actions cannot permanently lower unemployment, then that would mean that the Fed is powerless to fulfill one-half of its dual mandate.

Jazzbumpa said...

The two parts of the Fed mandate are in dynamic tension, anyway.

Wiki links not withstanding, I don't know that the Phillips curve is especially Keynesian - though Samuelson grabbed it with considerable enthusiasm.

It's empirical, despite the actually quite amusing attempt by the Lucas to derive it from am aggregate supply function tainted with expectations (I know - one of Keynes' ideas.)

Now that I think about your critical Fed assessment, I have to point out that I just said they are powerless to fight deflation - which means they can't fulfill the other half of their mandate either.

What this really indicates is the ineffectiveness of monetary policy at the zero interest boundary.

I guess I think of the Phillips curve as one of these things (the floaty device, not the curvy model) riding up an down on whatever causes the waves. Which is pretty much Noah's point.

Anyway - why am I channeling your old posts?

Cheers!
JzB

Stagflationary Mark said...

Jazzbumpa,

Now that I think about your critical Fed assessment, I have to point out that I just said they are powerless to fight deflation - which means they can't fulfill the other half of their mandate either.

November 17, 2010
The Sarcasm Report v.69

In other words, no matter what happens to interest rates we'll be able to point to the Fed's plan as a success.

Genius! And to think that I once thought the Fed was rather impotent.


Back to you.

Anyway - why am I channeling your old posts?

I might be a tad biased, but perhaps a proverb says it best. ;)

The Arthurian said...
This comment has been removed by the author.
The Arthurian said...

Well I think it is pretty neat that you got "best-fit" curves similar to Noah's. Your R^2 values are low, perhaps low enough that Samuelson et al should have been less inclined to take the observation as a hard-and-fast rule. But it WAS the golden age, and everything they did worked, and they got a little giddy because of it, I think.

"Notice how Noah assigns the data points to the various curves: '75 with '80 and '81; ... later 90's with the late 60's." Good years with good, bad years with bad. For me Noah's graph is evidence that the Reagan era was not as good as the golden age -- a point Krugman is repeatedly making.

Your approach differs from Noah's (it seems to me) because you expect to find chronological continuity where Noah does not. (I never thought about this before.) Your approach seems right. Still, one *should* see 1975 with '80 and '81, there in the upper right. Those are recession effects. One *should* see the late 1960s and the late '90s in the lower left. Those were good years.

The red years are certainly more messy than the pink ones on your graph. The flatter "best-fit" of the red suggests that increasing inflation had less of a trade-off effect on unemployment during 1974-1979. Or, that on average for the period little could be done to reduce unemployment.

The question remains: Does chronologicity matter for the Phillips curve? Noah writes: "Policy shifts and structural shifts in the economy will, over time, change the tradeoff between inflation and unemployment." Over time, he says. So yes, for him chronologicity matters. Despite his graph. But obviously those deep-recession years belong in the upper right, so what Noah did with them must be forgiven.

I don't like the phrase "structural shifts." It puts important stuff into a black box.

Your blue line totally ignores the changes in the tradeoff -- and the changes in the tradeoff are the most important thing!

Phillips offered the graph as an observation. Maybe we should treat it as such.

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