Let’s talk about the economics of mass destruction — the single most dangerous idea in economic policy… the Phillips Curve. Even if you don’t know it by that name, you’ve been its victim. The Phillips Curve is the formal construct representing the idea that full employment causes inflation.
We haven’t heard much of the Phillips Curve in the last couple years, because the economy had been in recession and unemployment has been on the rise. But think back to just a few short years ago — or to any time when the economy has been growing robustly — haven’t you heard things like “the economy is overheating” or “the pool of available workers is shrinking” and “the Fed will have to put the brakes on by raising interest rates.” Whenever it’s said — whether its on the evening news or in the minutes of a meeting of the Open Market Committee of the Federal Reserve — it’s treated as utterly axiomatic, beyond questioning, obviously true… like saying that rain coming down makes the streets wet.
But why should it be true? Suppose literally everyone who wanted a job had a job. Would inflation spin out of control for some reason just because everyone is working — earning more and producing more? Why? What kind of bizarre notion of the nature of money and markets would ever lead anyone to expect that?
And is it true? No — it is simply not. Did the persistent unemployment of the 1970s keep inflation in check? No — that was a decade of horrendous inflation. Did the rapid rise of employment in the 1980s and 1990s cause runaway inflation? No — inflation subsided to near non-existence in those decades. Just take a look at this chart from a paper just published by economist William Niskanen showing the relationship — or absence of a relationship — between inflation and unemployment. Niskanen calls it “white noise.” Do you see a Phillips Curve hiding in there? I don’t.
But never bother academic economists or power-mad economic policy wonks with mere facts. These are the same guys who insist that deficits cause interest rates to go up — despite glaring counterexamples right this very minute in both the United States and Japan. Just browse the speeches of Federal Reserve officials on the Fed’s Web site and you’ll see how deeply the most powerful — and presumably knowledgeable — economic policy experts in the world believe that prosperity causes inflation — and how sincerely they take it as their duty to limit prosperity for the sake of controlling inflation. Read this paragraph from a June, 2000 speech by then Fed Governor Lawrence Meyer, as he ponders just how much and for how long the Fed will have to slow the economy.
“…monetary policy does face a challenge–rebalancing aggregate supply and demand to contain the risk of higher inflation.
