Has the usefulness of the Phillips curve come to an end?

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The Phillips curve was created during the 1950’s and 1960’s, examining evidence for the past 100 years of economic growth. Whilst this characteristic held true for the early modern age, does it still have relevance in the modern world to aid policymakers? This essay will argue that whilst it can act as an effective baseline, like all models, it fails to accurately capture nuances and thus it may not be the most useful tool for policymakers to use.

At its inception, the Philips curve held true for the preceding century. And this inverse relationship between inflation and unemployment held true during the 1950’s and 1960’s. However, the validity of the model came under intense scrutiny during the 1970’s. Extended periods of stagflation illustrated how the model was unable to effectively model periods of high unemployment and high inflation. This would have limited the usefulness of the Philips curve for macroeconomic policymakers. However, the model was amended by monetarists who enabled the Phillips curve to shift. As a result, whilst less enumerated, the model is able to continue to be useful in modelling the impacts of economic policy. As a result, the Phillips curve continues to be an effective tool for policy makers in the modern era. However, this also makes the relationship between unemployment and inflation less valuable as it is not permanent and can dramatically vary across time and nations.

The Phillips curve can be highly useful to politicians and elected policy makers. The electorate places disproportionate weight on recent events. As a result, politicians may dramatically lower interest rates prior to an election. Theoretically, lower interest rates would increase the supply of money in the economy. As a result, unemployment would decrease from U1 to U2, as labour is a derived demand, the impact of this would be an increase in inflation from I1 to I2. The Phillips curve is thus, in theory, a useful tool for policy makers who can then use it to aid their re-election bids. However, this boom-and-bust economics strangles long run economic growth, due to inherent instability in the markets. This would cause lower standards of living across the nation. Moreover, whilst possible in theory, the UK monetary policies are controlled by the Bank of England. As they do not face elections, the UK is immune to these issues. In spite of this, it is still a fundamental issue in many developing and emerging economies, showing that the Phillips curve is still useful to some policy makers.

However, the effectiveness of the Phillip’s curve is not as strong as it was as it does not include the role of the international markets. The Phillips curve assumes that inflation is a purely internal issue. However, with the increasing globalisation of the modern world, inflation is an international phenomenon, despite domestic employment being highly unchanged. This breaks down the role between domestic employment and inflation. This was especially true after the 2008 financial crash when global interest rates were at remarkably low levels. As a result, the Phillips curve can no longer be used effectively by policy makers. This is significant as it also explains why the Phillips curve accurately depicts the early modern period but fails to do so in the modern age. Globalisation has rapidly expanded in recent decades, making the Phillips curve obsolete.

Moreover, the Phillips curve was conceived in an era when wages still contributed the most to business costs. As a result, reductions in unemployment led to extensive cost push inflation. This is no longer the case. Workforces have become increasingly automated, as a result, wages comprise a smaller portion of total business costs. This makes one of the key principles that the Phillips curve is based on simply untrue. Wage growth can no longer be substituted for inflation. Moreover, unemployment is not the sole determinant of wages. This creates a double falsehood. As a result, the Philips curve is not simply outdated, but did not accurately show the correlation since the industrial revolution. However, perhaps this assessment is too harsh. Wages remain the principal manner through which income is earned. As a result, unemployment is correlated to higher wages, which in turn leads to demand pull inflation. The model, therefore, is not fundamentally wrong but vague and would require far more detailed analysis to be an effective tool for policy makers.

In conclusion, the Phillips curve remains a basic model, from which policymakers can observe the predicted impact on the economy. However, whilst it shows the direction of the impact, the Phillips curve does not show the magnitude. As a result, it can only be used alongside other data to remain a relevant tool.

Disclaimer: Ben Goree was a member of the Labour party at the time this article was written. All views are held are his own.