Planet Money – Is economists’ favorite tool to crush inflation broken?

Intro

In this episode of the “Planet Money” podcast, the hosts explore the history and evolution of the Phillips curve, an economic tool used to understand the relationship between inflation and unemployment. They discuss how the Phillips curve was initially seen as a guiding principle for economic stability but later faced criticism and challenges. The episode also highlights the importance of the Phillips curve in monetary policy and the implications of its potential obsolescence.

Main Takeaways

Bill Phillips and the Birth of the Phillips Curve

• Bill Phillips, an electrical engineer turned economist, constructed a water flow model of the economy to study underlying forces.
• His machine, resembling a giant fridge, revolutionized economists’ understanding of inflation and its control.
• Phillips discovered a trade-off between unemployment and inflation, known as the Phillips curve.

The Rise and Fall of the Phillips Curve

• The Phillips curve gained popularity among economists, offering a sense of optimism and freedom in economic policy-making.
• Milton Friedman’s critique highlighted the curve’s oversimplification and failure to account for inflation expectations.
• The phenomenon of stagflation in the 1970s challenged the Phillips curve’s validity.

Phillips Curve 2.0 and Alan Blinder’s Experience

• The Phillips curve underwent revisions to incorporate more complex factors influencing inflation and unemployment.
• Alan Blinder, Vice Chair of the Federal Reserve, utilized the Phillips curve 2.0 to control inflation in the 1990s.
• Blinder’s success in achieving a soft landing for the economy emphasized the usefulness of the revised curve.

The Uncertainty of Losing the Phillips Curve

• Professor Blinder, once a believer in the Phillips curve, no longer considers it a reliable tool due to stagnant inflation.
• The loss of the Phillips curve poses challenges for monetary policymakers in predicting and controlling inflation.
• The complexity and constant change of economies make it difficult to find universal truths.

Summary

The Birth and Evolution of the Phillips Curve

Bill Phillips, an electrical engineer turned economist, built a water flow model of the economy in his garage. This model, resembling a giant fridge, allowed him to understand the underlying forces of inflation and unemployment. Phillips discovered a trade-off between the two, known as the Phillips curve, which became a guiding principle for economic stability. However, Milton Friedman’s critique and the occurrence of stagflation in the 1970s challenged the curve’s validity.

Phillips Curve 2.0 and Alan Blinder’s Experience

The Phillips curve underwent revisions to account for inflation expectations and other influential factors. Alan Blinder, as Vice Chair of the Federal Reserve, utilized the revised curve to control inflation in the 1990s. His success in achieving a soft landing for the economy demonstrated the usefulness of the new Phillips curve.

The Uncertainty of Losing the Phillips Curve

Professor Blinder, once a believer in the Phillips curve, no longer sees it as a reliable tool due to stagnant inflation despite economic fluctuations. Losing the Phillips curve poses challenges for monetary policymakers in predicting and controlling inflation. The complexity and constant change of economies make it difficult to find universal truths.

Conclusion

The Phillips curve, once hailed as an important tool for understanding and controlling inflation, now faces uncertainty and criticism. Its evolution and challenges reflect the complexities of economics and the constant need for adaptation. As economists navigate the ever-changing economic landscape, the search for reliable tools and universal truths continues.