Sorry. It suddenly came to me this morning: a simple (and now blindingly obvious) way to reconcile an apparent contradiction in my own thoughts.

As a lot of people in different countries have noticed, the observed Phillips Curve now looks very flat. Certainly a lot flatter than it did in the past.

And I've been saying of course it looks flat; that's because central banks are now targeting inflation and were doing all sorts of different daft things in the past. The whole point of targeting 2% inflation is to try to make the observed Phillips Curve as flat as possible at 2%. And not just the Phillips Curve; whatever you put on the horizontal axis, if you've got inflation on the vertical axis the central bank is trying to make that observed curve flat. This point is starkest if we assume the central bank has rational expectations and is targeting its internal inflation forecast at 2% given a (say) 2 year targeting horizon. Deviations of inflation from 2% are then the central bank's inflation forecast errors, and if the central bank has rational expectations those forecast errors must have a 0% correlation with any variable or set of variables in the bank's information set 2 years prior.

If the central bank had an NGDP target instead of an inflation target, we might see the observed Phillips Curve having the "wrong" slope. If the bank foresees a period of higher than normal real growth and falling unemployment, it will try to make inflation come in below normal to keep NGDP growth on target.

It's a bit like the standard simultaneous estimation problem in econometrics: If you plot the correlation between P and Q, are you estimating a demand curve or a supply curve or a mix of both? The observed curve could slope either way. Except in this case it's like having a monopoly supplier of apples who adjusts the supply to whatever he thinks will keep the price of apples falling at 2% (the value of money falls at 2% if there's 2% inflation).

The flat observed Phillips Curve is just an artefact of the new monetary policy regime; a statistical illusion.

But at the same time I felt that something structural had indeed changed, and the Phillips Curve really had gotten flatter. The 2008/9 recession really did look like a standard recession caused by a negative shock to Aggregate Demand, and that recession lasted a longish time, and inflation should have fallen below target by more than it did, and certainly not stay the same on average, or even rise in some cases. Inflation targeting works well if "Divine Coincidence" is true; if inflation being above/below target coincides with output and employment being above/below where they should be from the point of view of monetary policy, so the central bank is too loose/tight. Deviations of inflation from target work as a good proxy for monetary disequilibrium, in other words. And Divine Coincidence seems to look a lot worse over the last 10 years than I thought it would look before the recession. Something structural did seem to have changed that made the Phillips Curve flatter, so the same amount of noise shifting the flatter Phillips Curve up and down meant inflation worked as a far worse proxy for monetary disequilibrium. Inflation had become much stickier. And maybe it was inflation targeting itself that had made inflation stickier, destroying its own signal of monetary disequilibrium. So we ought to switch to NGDP targeting instead.

But what evidence could justify my sense that something structural had changed, when a flat observed Phillips Curve is what we would expect?

**It's not that the observed Phillips Curve is flat; that is unsurprising. It's that the observed Phillips Curve is flat and long; that is what is surprising.**

It's the difference between flat and short, like this:

xxxxxxx

And flat and long, like this:

x x x x x x x x x x

where each x is an observation - a point in {inflation,unemployment} space.

Either the structural Phillips Curve really has gotten flatter, or else the variance of the natural rate of unemployment is a lot higher now than it used to be, and that does not seem plausible to me.

I feel much better now I've resolved my own cognitive dissonance.

## Recent Comments