Bernanke and The Slope of the Phillips Curve

Here is a direct quote from Ben Bernanke today.

“I guess the — the question is, does it make sense to actively seek a higher inflation rate in order to achieve a slightly increased reduction — a slightly increased pace of reduction in the unemployment rate?

The view of the committee is that that would be very reckless. We have — we, the Federal Reserve, have spent 30 years building up credibility for low and stable inflation, which has proved extremely valuable in that we’ve been able to take strong accommodative actions in the last four, five years to support the economy without leading to an unanchoring of inflation expectations or a destabilization of inflation. To risk that asset for what I think would be quite tentative and perhaps doubtful gains on the real side would be, I think, an unwise thing to do.”

So, this is a clean example of “game theory” at work.    A student who got an A in econ 101 might think that this is simply a question of what is the slope of the Phillips Curve.  But, what is a Phillips Curve?  Does it really exist? or is it a statistical illusion?

Dr. Bernanke is aware that the Fed is a strategic actor and there is a “chicken” and “egg” element here.  The Fed’s choices affects private sector investment and expectations of private sector trends influence the Fed’s current behavior.  I mentioned this in a previous post and this triggered some disgruntled comments.    It appears that macro economists are still learning about their subject.   When experts disagree about what is “good policy” and when we know that we don’t know how a macro economy works, what is “good” public policy?  As usual, I would suggest that we run some experiments to increase our knowledge base.

 

 

 

Comments

  1. Bruce Wilder says

    In 1987, Paul Kennedy published The Rise and Fall of the Great Powers about the experiments, we have already run, and the results. Our knowledge base shrank anyway.

  2. says

    Bernanke’s defence is a lot less convincing coming from Trichet, Draghi and the ECB, who face recession and a debt death spiral rather than the USA’s anaemic but real recovery.

  3. J. Michael Neal says

    Why can’t they be credible at a 4% or 5% rate of of inflation instead of under 2%?

    • SamChevre says

      As I understand the theory, if the inflation target had been 4-5% for the last 25 years, and inflation had been kept between 4-5%, then having a credible 4-5% policy would be easy.

      But if in this environment the target inflation rate is changed, it would be difficult to convince everyone that the new rate would be stable, rather than changing again as political/economic pressure made it temporarily advantageous.

      I am still very unconvinced that either monetary or fiscal management can help in an environment where real resource (especially oil) costs increase relative to other goods.

  4. Anderson says

    It’s simple: the Fed does not care about unemployment.

    Unemployment hurts the little people; inflation hurts Wall Street.

    End of discussion.

  5. larry birnbaum says

    I think you misunderstand the nature of the disgruntlement that met your previous post. It wasn’t your main point that the Fed as an agent and it’s constituent elements as agents need to be modelled and understood. It was the ancillary and it seems to me quite orthogonal claims about the causes of the current situation — inserted why? — that irritated me and others.

  6. politicalfootball says

    It was the ancillary and it seems to me quite orthogonal claims about the causes of the current situation — inserted why? — that irritated me and others.

    Inserted why? Because Prof. Kahn wants to obfuscate. It’s nice of you to give him the benefit of the doubt and say that he “[misunderstood] the nature of the disgruntlement,” but Prof. Kahn is able to read, and it’s impossible to believe that he didn’t understand our objections.

    And if there were any doubt about Prof. Kahn’s intent, he’s quite clear here.

    When experts disagree about what is “good policy” and when we know that we don’t know how a macro economy works, what is “good” public policy? As usual, I would suggest that we run some experiments to increase our knowledge base.

    In fact, there’s an ongoing natural experiment that has completely vindicated the traditional economic approach (again). We actually have quite a lot of information about the workings of the economy. Dean Baker describes how David Brooks uses a similar argument to similar ends.