Has the Phillips Curve disappeared or just flattened?
In economies as diverse as Japan, the UK, the USA, and Canada, the traditional shape of the Short-Run Phillips Curve (SRPC) has not been observed statistically recently.
In the last few years, unemployment has been falling in these economies. This would suggest (if the SRPC is correct in predicting a trade-off) that inflation should be rising. But it has not. Indeed in Japan deflationary pressures continue to be worrying and the Bank of Japan is still striving to attain its target of 2% inflation.
What are some possible reasons for this?
- a lowering of inflation expectations (the SRPC is still there but it has shifted left).
- changes to the structure of the labor market have caused a fall in the natural rate of unemployment (the Long Run Phillips Curve has also shifted left). Frictional unemployment is lower because the labor market (with the help of the internet) has become more efficient at matching the unemployed workers to unfilled vacancies. Structural unemployment is lower because there have been educational reforms and more training provided.
- unemployment is not actually as low as it appears, because there is a lot of underemployment (particularly in Japan,where many people who have a part-time or temporary or non-regular job would prefer to have full-time employment).
- labor has less power or willingness nowadays to push up wages even when the labor market is tight. In Japan, at least, job security is looked on as more important than rising wages. Labor Unions appear to be less forceful and less willing to strike.
- this could be due to globalisation. Firms now have the power to move their factories overseas, if domestic wage costs are seen as too high.
What are the implications?
Policy makers have relied on models like the Phillips curve to predict inflation and decide whether to have contractionary or expansionary policies. It is going to be much harder to know where inflation and inflationary expectations are heading.
However, the good news is that possibly economies can now achieve high growth and low unemployment without needing to worry about inflation surging.
Both the Keynesian and the New Classical Models may need re-designing. Is the concept of the “inflationary gap” no longer valid?
OVERALL implications for JAPAN:
The economy is experiencing more sustained growth than at any time in the last 25 years. Real GDP has risen for six quarters, based partly on higher investment and partly on government expenditures. Thus the “output gap” is now judged to be an inflationary gap (actual GDP>potential GDP). In a recent survey of Japanese companies, 70% said they were planning price increases over the next year and the lowest wages are improving (partly aided by a rise in the legislated minimum wages).
Consequently it is possible that Japan will soon escape from the deflationary spiral due to the increasingly tight labor market. This would imply that the Phillips Curve does still exist in that lower unemployment will be associated with positive inflation.
For more information and charts look at
For the situation in Japan; https://www.leggmason.com/en-us/insights/investment-insights/has-the-phillips-curve-flattened.
For the situation in Canada: https://economics.td.com/phillips-curve-for-canada