Glenn Hubbard (“The White House and the Fed must learn to talk to each other”, Opinion, July 30) asked “whether the US central bank still has the tools to achieve the desired level of inflation” but provided no answer.
The answer is no. Economists have two theories of inflation: the monetary theory — too much money chasing too few goods, championed by Milton Friedman and his followers, and the Phillips curve theory, which posits a structural relationship between the unemployment rate and the inflation rate so that when the unemployment rate falls, the inflation rate necessarily increases. Neither of these theories have had any validity or predictability.
The statistical relationship between various measures of money and inflation was reasonably strong during the postwar period, but evaporated in the early 1980s and never returned. This is why money is seldom, if ever, mentioned when policymakers discuss monetary policy.
In a paper the New Zealand economist AWH Phillips published in 1958, he showed there was a negative relationship between the annual growth rate of nominal wages and the unemployment rate in the UK during the period 1861-1913. Economists subsequently found a similar negative relationship between inflation and the unemployment rate for the US for the 1950s and 1960s. This relationship was never particularly strong and withered over time, in spite of the many heroic attempts to revive it.
Ardent proponents of the Phillips curve, like Alan Blinder, acknowledge that there has been no relationship between the unemployment rate and inflation over the past 20 years, but the truth is the Phillips curve died much earlier.
The demise of these statistical relationships is not surprising. In 1976, the Nobel laureate Robert Lucas warned economists that historical relationships in economic data should not be considered structural. Given the lack of a structural relationship between monetary policy actions and inflation, there is no reason to believe that central banks have the ability to achieve a desired rate of inflation.
Indeed, it is hardly surprising that central banks’ historically low interest rate policies and massive bond purchasing programmes during the past decade have had no significant effect on inflation.
Retired Vice-President and Economics Adviser, Federal Reserve Bank of St Louis, Des Peres, MO, US
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