Morning Report: The death of the Phillips Curve

Vital Statistics:

Stocks are higher this morning on no real news. Bonds and MBS are down small.

The stock market has been rocking this month. It turns out this is the best August in 30 years.

We will have a decent amount of data this week, with the jobs report, construction spending, ISM and productivity. The markets will be closing early on Friday ahead of the Labor Day weekend.

Fed Vice Chairman Richard Clarida said the Fed isn’t looking to raise rates even if unemployment starts falling. “My colleagues and I believe that this new framework represents a critical and robust evolution of our monetary policy strategy that will best equip the Federal Reserve to achieve our dual-mandate objectives on a sustained basis in the world in which we conduct policy today and for the foreseeable future,” Clarida said in prepared remarks for a speech to the Peterson Institute for International Economics. The “new framework” he is referring to is the asymmetric risks around inflation, which means that the Fed will let the labor market run hot before raising rates. Essentially this is the death of the Phillips Curve.

The Phillips Curve was a theory that came from the 1960s which said that as unemployment falls, inflation will rise. The Fed had used that sort of model in the past to help guide monetary policy, and the new monetary framework basically says that the Fed will no longer slow the economy pre-emptively as unemployment falls. The Fed will now wait until inflation is running above its 2% target before raising rates. We saw unemployment in the mid 3% range, and inflation remained under control. The punch line is that rates will stay at the zero bound for years unless we get some sort of unexpected increase in inflation.

Author: Brent Nyitray

In the physical sciences, knowledge is cumulative. In the financial markets, it is cyclical View all posts by Brent Nyitray