Saturday, May 26, 2018

Is The Phillips Curve Dead In Japan? Maybe not

See In Booming Japan, the Phillips Curve Is Dead: Unemployment is down but inflation isn’t budging. Why companies resist raising prices by Greg Ip of The WSJ. Excerpt:
"By several measures, the economy is overheating. Total activity is now 1.5% above normal capacity, the Bank of Japan estimates. Unemployment, at 2.5%, and businesses’ spare capacity are both the lowest since 1993, when the 1980s property and stock bubbles were still deflating. There is more than one job opening for every active job seeker in all 47 prefectures. “This clearly means there is much more demand than supply,” says Masatsugu Asakawa, vice-minister of finance. “Almost every indicator has been great. The only mystery is the weak performance of prices.”

In defiance of the Phillips curve, these intensifying bottlenecks have had only limited impact on wages, and none on prices. Inflation in the year through April was just 0.4% when fresh food and energy are excluded. That’s better than the outright deflation that generally prevailed from 1998 to 2012, but not by much, and it’s a far cry from the Bank of Japan’s 2% target. This is a problem, because if inflation gets stuck at or below zero, interest rates also get stuck at zero, robbing the central bank of its ability to stimulate the economy by cutting rates."

But that is only recently. Below is one of the graphs from the article and since the late 1990s, there have been periods in Japan when the unemployment rate fell while the inflation rate rose.

Look at the two green lines. It looks like from 1998-2002, unemployment and inflation go in the opposite direction (the unemployment rate rose while the inflation rate became lower). That is what the Phillips curve predicts.

Then it looks like they moved in the opposite direction for the next 2-3 years (the yellow lines), although unemployment fell while inflation rose.

Then starting in 2009, they moved in the opposite direction again for a couple of years. Red lines.

And from 2010-2015, they moved in the opposite direction. Black lines.

So maybe for 13-14 of the last 19 years, things have gone the way the Phillips curve would have predicted. And certainly since 2009 except for the last 2 years.

AD and SRAS help explain what is going on. As AD increases or shifts to the right, prices rise. But the increases get bigger. Q or GDP increases, which lowers unemployment, but less each time. That tells the same story as the Phillips curve. But, what if supply shifts to the right? (which I don't show). If SRAS shifts more to the right than AD, then the rise in prices might be slight (and inflation could be less than what it was in the past) while the increases in Q can be large and the unemployment rate falls. That is the opposite of the Phillips Curve. So the Phillips Curve has to assume a fixed SRAS.

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