Fed Study Says It’s Solved the Murder Mystery of Who Killed the Phillips Curve

“If you put it in a murder mystery framework — ‘Who Killed the Phillips Curve?” — it was the Fed that killed the Phillips Curve,” St Louis Fed President James Bullard quipped back in 2018.

While the notion of a central bank deliberately ending the life of an economic model might seem insidious, Bullard’s comments were actually a humblebrag; he attributed the passing of the Phillips Curve — the idea that wages tend to rise faster when unemployment is low — to the Fed’s commitment to stable inflation.

“The Fed has been much more mindful about targeting inflation in the last 20 years,” Bullard said back then. “That has resulted in lower, more stable inflation in the U.S.,” he said, adding “so there isn’t much of a relationship anymore between labor market performance and inflation.”

Today, inflation is at its highest in three decades, but the search for the Phillips Curve killer continues. A working paper, published as part of the Fed’s Finance and Economics Discussion Series, suggests a culprit may have been found. Rather than stable inflation-targeting from the Fed, authors David Ratner and Jae Sim place the blame squarely on the loss of workers’ collective bargaining power since the 1980s.

“We argue that the ‘missing inflation’ puzzle is due to a collapse of workers’ collective bargaining power that has in turn left the slope of the Phillips Curve nearly flat,” Fed board economists Ratner and Sim said. “We find consistent evidence that in cities and states with higher union density, the slope of the Phillips Curve is steeper.”

Trying to find the Phillips Curve killer isn’t just a matter of academic interest. Long the default model for estimating inflation, the Phillips Curve forms the basis for modern monetary policy — even though its fundamental relationship doesn’t seem to have held true for years.

Simply put, the Phillips Curve posits that inflation and unemployment move inversely to each other. When inflation goes up, unemployment should go down as economic growth picks up, and vice-versa. If inflation is low, it means growth is sluggish and there are fewer jobs.

In the aftermath of the Great Financial Crisis, however, the Phillips curve toppled over and essentially became flat. Inflation remained stubbornly below the Federal Reserve’s 2% target even as the unemployment rate drifted to as low as 3.6%. That prompted more than one economist to declare the Phillips Curve dead, with numerous papers attempting to examine the economic model’s morbidity.

In the new paper, researchers Ratner and Sim revisit the topic and conclude: