Phillips Curve & Okun’s Law
Background of Issue:
Covid-19 was a turbulent time for the world as a whole including the U.S. economy which saw extreme spikes in unemployment and inflation, due to cost-push inflation, and de-anchoring the Phillips Curve (PC). Which according to the original PC and the accelerationist PC shouldn’t be possible, but it was, leaving policymakers like Jerome Powell and President Joe Biden with quite the predicament. However, by stimulating the economy with government spending in the form of stimulus packages, and later increasing interest rates allowed the U.S. economy to avoid a hard landing. Leaving us where we are today, unemployment sits at 3.9%, seasonally adjusted core inflation sits around 4%, and fed funds rates are around 5.3%.
Predictability:
Looking at the PC and Okun’s Law (OL) gives us a good idea of the relationships between unemployment, inflation, and output. The Phillips Curve shows the relationship between the unemployment rate and the inflation rate. With the current parameters of 4% seasonally adjusted core inflation and unemployment around 3.9%, we can that see broadly speaking the relationship holds. Next, looking at Okun’s Law we can see that this relationship also holds as unemployment in the past month has increased by roughly .5%, and output growth (measured in GDP) has decreased over the past quarter. Having the PC and OL graphs operating correctly is very beneficial for policymakers as it shows changes in policy’s effects on the economy can be in theory forecasted more efficiently. This was not the case from 1970-1995 due to the flattening PC and the need for economists to switch to the accelerationist PC in order to have more accurate forecasting.
Moving Forward:
How do economists like Jerome Powell, Janet Yellen, and President Biden move forward with the economy given the current economic conditions? Firstly, I think increasing interest rates should not be in the question for Jerome Powell and the Federal Reserve. Since increasing the fed funds rate to between 5.25-5.5% core inflation, not seasonally adjusted has fallen from “has fallen to around 2.8% recently, down from 4.8% one year ago” (Timiraos, 2024). Proving that the increasing of interest rates have been effective in dealing with inflation but as we know due to the Phillips Curve when inflation decreases unemployment tends to rise which can hurt an economy's GDP, and can lead to a recession. “Economists at the National Bureau of Economic Research (NBER) measure recessions by looking at nonfarm payrolls, industrial production, and retail sales, among other indicators, going far beyond the simpler, two-quarters of negative GDP measure” (“Recession: Definition, Causes, Examples and FAQs”). While the stock market has been on a tear recently, I still contend that the biggest bullet the American economy still needs to dodge is a recession. With an inverted yield curve, rising unemployment, and decreasing percent changes in GDP it seems as though now is the opportune moment for the Federal Reserve to begin cutting rates. Which by doing so should stimulate the output of the U.S. economy as a whole due to the inverse relationship between interest rates and planned investment. However, some serious concerns need to be considered by the Federal Reserve before they begin “aggressively” cutting interest rates. With the main concern being that inflation may be quite sticky according to Vanguard Economist Joseph Davis, “expectations of rate cuts would prove counterproductive to the final stage of the inflation fight. Given the potential for sticky services prices to keep inflation from falling, there is a growing prospect “that they should not be cut at all,” he said.” (Timiraos, 2024). In my opinion from all the data available to the public via the Federal Reserve Bank of St. Louis, there is a lot more benefit to slowly cutting interest rates than there is from waiting for another year before cutting. It appears Jerome Powell feels the same way as at his latest Federal Reserve meeting he announced that Federal Reserve officials still see three interest rate cuts coming this calendar year.
