Full employment without a Phillips Curve

This note raises a question I hope to be able to make some progress on over the coming year.  How might the Fed and inflation interact in an environment of full or overfull employment, if the Phillips Curve were fully defunct, and not just flat? I still cling to the hope the Phillips Curve is out there somewhere, because I do not have an obvious replacement.

The question is a trickier and perhaps more relevant question than you might imagine.  In the presence of an employment overshoot, the absence of a Phillips Curve would probably itself reduce recession risk. It would raise the prospect of employment returning to “normal” from above slowly and in a non-destabilizing way. That would be strongly against the historical pattern, but it seems plausible, if the Phillips Curve were indeed to be dead.

On the other hand, the idea that the Fed needs to ratchet growth down from well-above-trend to around trend does not seem to be that sensitive to the presence of the Phillips Curve. And I think this point may be missed by analysts who think that low inflation necessarily translates into additional running room for the economy.  They may be confusing the fact that the required growth moderation is now ongoing with the more (excessively) optimistic idea that a meaningful growth moderation can be avoided. Related, they may be confusing the path of the policy instrument with the Fed’s objectives.

I elaborate in this note, trying to distinguish between what I think we know and what would be good to know.