There is Too a Short-Run Phillips Curve

The editorial page of the Wall Street Journal says there's no short-run Phillips curve, i.e. no short-run tradeoff between inflation and measures of real aggregate activity such as GDP and unemployment. And there is criticism of the Fed for hinting that such a tradeoff exists:

A Pause That Digresses, Editorial, WSJ: The Federal Reserve has seemed unsure how to proceed on monetary policy for several months, and yesterday it proved it. The Fed's Open Market Committee decided not to raise interest rates again -- not because inflation is contained but because it says the economy is slowing. Uh, oh. Here we go again, back to the era of the Phillips curve, the economic theory that postulates a trade-off between inflation and unemployment. We thought Paul Volcker and Alan Greenspan had buried that notion years ago. But apparently it lives on like Arthur Burns's ghost in the attic of the Fed, ready to inhabit a new Chairman who has inherited an inflation and is afraid that breaking it will send the economy into recession.

If there is no short-run tradeoff between output/unemployment and inflation, then the WSJ editors should have no objection to the Fed raising the federal funds rate (i.e. cutting money growth) by whatever amount is necessary to hit, say, a 1% inflation rate in 3-6 months (with no short-run tradeoff, this amount of time isn't needed, but let's not be overly demanding). Rates of 15%, 20%, 25%? 50% if needed? No problem. It doesn't matter how high rates go, unemployment and output won't change in the short-run - so just get rid of inflation no matter how high rates need to go.

I bet the WSJ editors, and their readers in the business community, would worry about GDP falling. If so, they believe in a short-run Phillips curve no matter what they say in public. Their idea of the short-run might be a shorter time period than mine, and that can affect policy choices, e.g. how aggressive to move against inflation, but that's a matter of degree, not substance.

Update: PGL at Angry Bear follows up. I noted the following in comments to his post:

I thought about mentioning the 82 recession as an example of the SR tradeoff, the 82 recession is widely acknowledged as one of the clearest examples of a recession induced by tight monetary policy, but credibility issues also played a role there. There is a difference between a movement along a SRPC, and a shift in the SRPC. With credibility and a frictionless world, inflation can be removed costlessly - the SRPC shifts immediately with any change and keeps output at the natural rate. But without credibility, or with frictions (including information frictions), the SRPC becomes operative.

Lack of credibility helps to explain the severity of the 82 recession - the SRPC wouldn't shift until people believed the Fed was actually serious about fighting inflation contrary to recent experience and that took awhile.  I don't think credibility is a problem currently (though with a new Fed chair that could be questioned), but I think short-run rigidities are an issue and this is what moves the economy along the short-run PC. That puts me in the New Keynesian camp. I understand other schools of thought have different interpretations.

To claim fighting inflation is costless, or to say that there is no SRPC says such short-run rigidities do not exist. My point was that if in fact they don't exist, then why not call for getting rid of all inflation immediately.

I think the editors at the WSJ would acknowledge such rigidities, but likely argue they are quickly resolved (so no need for a policy intervention) - but my reading of the empirical evidence does not support that position. There is controversy here - see, for example, the recent NBER papers Rudd and Whelan (at FRB) and by Gali, Gertler, and Lopez-Salido (WP # 11788) for a debate over traditional New Classical views of the Phillips curve versus the New Keynesian hybrid Phillips curve used more recently.

Update: See here for more on the inflation-unemployment tradeoff.

Comments

[reason]

Why take the Wall Street Journal Editorial seriously? I thought the concensus was it is consistently trash.

[No Name]

Sometimes the editorial page has something, but usually the guess commentators they have on.

And I think they are more worried that the Fed is paused here because of growth concerns with inflation looking bad. And basically the WSJ said no, growth moderating might not calm the inflation beast. Not with wages picking up.

Taking it to an extreme, yes they look very foolish.

[bakho]

Don't bother with the WSJ editorials. They are worthless. The news is pretty good.

Does the recent failure of Congress to raise minimum wage affect the Fed decision to pause? as in continuing to deflate the min wage (real dollars) puts a brake on possible wage inflation.

[slink/js paine]

wonderful turn here doc thoma...

take their absolute nyet
and drive em crazy with its consequences

then again
the vast highly visible bald spot
in "our fair science"
right where the price makers
make or take their prices
twists my linens some at nite

i know i repeat myself here
but
i don't like any
micro price decision story
i'm told
at least not any
the various
formal models
can fully model

and till we get one

better to rely on common sense

baumol in an essay a few years ago
pointed out

sometimes economics corrects
miss applied horse sense that's nonsense

like a gubmint is like a household
so if it borrows like a household it ......

but other times

the horse sense makes monkeys
of the gyro gear loose theories

that would claim
as pre turbulence flight science claimed

"my calculations based on advanced air o dynamic equations
prove conclusively
flies can't possibly fly "

[pgl]

The credibility argument strikes me as a variant of the classical school. I remember back in 1983 when we Keynesians noted that the Reagan disinflation was not as costless as the Lucas-Sargent models would have us believe, some excused the forecast errors of the rational expectations cum market clearing model by saying people didn't trust policymakers. OK, you might have been a bit confused with Reagan's fiscal fiasco but the credibility argument forgets the fact that Volcker was crystal clear in what he was doing. In a w word, the credibility excuse struck me as not being a credible explanation.

[slink]

"the SRPC wouldn't shift until people believed the Fed was actually serious about fighting inflation contrary to recent experience and that took awhile. "

mark sir
way back with me
its 1982 all over again
please put me inside the big corporate
price makers heads here
can you ????

are you talking wage demands ???
then where
are the union leaders heads at ???

volcker has been strangling the economy for one two three nearly four years now ....
interest rate fever has skied
and will be braking right about now as i recall
--------------------

as to the word "frictional"
the less said about that
bottomless
repository of theoretical ignorance the better

[lonesome moderate]

I don't think that it was widely understood or believed in the seventies that the Federal Reserve was the agency that fought inflation. That's why it took so long for the Fed's policies to have the needed effect. It wasn't that the press and public didn't think that Volcker was serious. It's just that there was widespread skepticism that anybody could control inflation, after a dozen years of nonsense from our elected leadership about how they were going to "Whip Inflation Now". That's how I remember it, anyway.

Things are different today. Hardly anybody really understands just what it is that the Federal Reserve does, but it's widely accepted that they're the ones whose job it is to control inflation. This may also be part of the reason the fed decided to pause--since they have a lot more credibility now, there is a lot less danger of falling short, and a correspondingly greater danger of overshooting.