Our rock star Fed Chair – Janet Yellen loves photo ops with unemployed auto workers and college students majoring in art appreciation who don’t understand why they can’t get jobs – has been saying all year that the Fed will raise rates before yearend. The obvious time to get started was the September meeting of the Open Market Committee, but Yellen blinked.
Not only did she blink, knocking billions of dollars of market value off the world’s equity markets, but she also published a commentary so bleak that investors panicked and knocked more billions of dollars off stock prices. And then, instead of noticing her error and issuing a simple and reassuring statement – she didn’t even have to invent it, she could have plagiarized it: “I’ll do whatever it takes” – she published a 31-page treatise complete with 34 footnotes, 40 literature references and an appendix.
Nobody read it, of course, because these days no one can read anything longer than a tweet. So, purely as a public service, I’ve taken it upon myself to read past the first 140 characters and to pass on to my readers the news Yellen was trying to impart.(1)
In order to steel myself for this task, I imagined that I was a tenured professor in the economics department at, say, Berkeley, and that I was reviewing a paper written by a candidate for the M. Econ. degree. After plowing through the turgid prose, I sighed and awarded the paper the C- it deserved. The paper suffers from many faults, aside from the fact that it was published in the first place, but given the limitations of space we’ll only look at three of them.
The Dreaded Phillips Curve. The first problem is that Yellen drags the gasping near-corpse of the Phillips curve(2) onto page 16. The Phillips curve, in case you forgot, describes the supposed inverse relationship between rates of unemployment and rates of inflation. Especially as unemployment declines toward so-called “full employment,” which, with bizarre accuracy, Yellen puts at 4.9% (not 4.844%??), inflation won’t be far behind and, therefore (says Yellen) the Fed needs to raise rates before inflation happens. You see, its easier to contain inflation than to chase it down and kill it after it’s escaped from the barn.
In most disciplines, the notion that inflation might rise once everyone has a job and therefore employers have to bid up to find people to hire would be blitheringly obvious. But in economics, this is what passes for insight. The trouble with the Phillips curve, however, is that it appears to be wrong.
There are lots of reasons why it might be wrong: just because an economy is at “full employment,” for example, doesn’t mean that everyone has an ideal job. Many employees might have utterly lousy jobs that they’d leave in a heartbeat. (That appears to describe today’s economy, in fact.) Maybe there is an information asymmetry between employers and employees. Maybe it doesn’t matter what workers think because labor unions have almost become extinct.
Or maybe, just as a really wild guess, the labor component of just about everything has disappeared into the noise so that, even if wage inflation arises, that won’t infect the broader economy.
Maybe some of these reasons explain why something like six Nobel’s have been awarded to critics of the Phillips curve, or why, though Yellen seems not to know it, the Fed itself debunked the Phillips curve about five months ago: “Economists have long posited that the Phillips curve may be nonlinear and convex and that inflation may respond asymmetrically to declines in employment above versus below the natural rate of unemployment.”(3) (That’s economic gibberish for “the Phillips curve is a screwy idea.”) Merely for failing to conduct a recent literature search we are forced to drop the grade a full letter, from A to B.
Inflation-anchoring. This odd concept means that if the central bank does its work, then a brief increase in prices (say, driven by the cost of imported goods) won’t be interpreted by the buying public as an outbreak of inflation. In other words, people will have confidence in their central bankers. Yellen states, “On balance, the evidence suggests that inflation expectations are in fact well anchored at present.” (page 14) We can certainly agree with the lady that no one expects an outbreak of inflation, but this hardly suggests that people therefore have confidence in their central bankers. Quite the contrary – the Fed’s inflation target is 2%, but the market expects that it will rise no higher than 1.3%. In other words, people don’t have confidence in the Fed’s ability to hit its own inflation target. Down another letter, I’m afraid: C.
Excuses. Finally, instead of admitting that the Fed has screwed up royally and should be thinking creatively, Yellen announces that “the recent shortfall of inflation from our 2% objective is attributable to special factors…” (page 17) Huh? Whenever inflation is too high or too low, its always caused by “special factors” – an OPEC oil embargo, just to mention one. But the Fed’s job is to deal with these “special factors” and ensure that inflation meets its target. We’ll be generous and decide that blaming her failure on outside forces reduces the grade only half a letter: C-.
I have no idea whether the Fed will raise rates this year or not. But I do know that if they do it will be only to avoid further humiliation to their chair. And I do know that if they don’t it will mean that the inmates have taken over the asylum. In either case, it’s a hell of a way to run a central bank.
(1) I admit I’m not an economist, but I did stay at a Holiday Inn Express last night. Ha, ha, ha, what I meant to say is that I did study economics in college. Unfortunately, Dismal Science 101 met at 8 a.m. on Saturday mornings. If you pause to ask yourself what a person would have to be doing on Friday night in order to make an 8 a.m. class on Saturday morning, you will know everything you need to know about people who want to be economists.
(2) The Phillips curve was described more than half a century ago, when it might even have made sense, by New Zealand economist William Phillips.
(3) Anil Kumar and Pia Orrenius, “A Closer Look at the Phillips Curve,” Fed Working Paper, Federal reserve Bank of Dallas, May 2015.
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