OPINION: New Zealand’s contribution to economic theory is not deep. Indeed, our greatest economic claim to fame is the MONIAC (Monetary National Income Analogue Computer), designed by Dr Alban William Housego Phillips, who called himself Bill, for understandable reasons.
Phillips designed a machine where water represented the flow of money through the UK economy. It became a success and a number were built. One of them was kindly donated to our reserve bank where a working model is kept in their museum.
I have been informed that they turn it on from time to time.
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Reserve Bank Governor Adrian Orr expressed concern in August about the situation recent homebuyers might find themselves in, and since then prices have been rising rather than falling.
Despite this wonder, Phillips is best known for his eponymous curve. In 1958, Phillips wrote a short and detailed article revealing that there seemed to be a correlation between rising inflation and falling unemployment.
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It was hailed as a revelation; governments could reduce unemployment by indulging in a little inflation; and they did. During the 1970s, there was worldwide acceptance that allowing prices to rise would result in the employment of the unwashed large.
Much to the delight of the Keynesians, this policy seemed to work for some time; until we have stagflation where high unemployment and inflation have existed as evil handmaids for almost two decades.
What Phillips actually said, if anyone had bothered to read his article, was that during times of high demand for labor, companies would make offers to raise wages. This Kiwi gentleman never said you could trade inflation and unemployment.
I mean, the paper is linked above. It does have a few graphics in it, but if even this aging hack can understand what Phillips was saying, it seems a generation of the best bureaucratic minds of the 1970s might have understood his analysis.
“The aim of the present study is to see whether the statistical evidence supports the hypothesis that the rate of change in monetary wage rates in the UK can be explained by the level of unemployment and the rate of change in unemployment. .. ”
Always; people read what they should read, not what is written. The Phillips curve has become a thing; and demystify it too. Seven Nobel Prizes have been awarded for showing that the imagined relationship is not real.
There is, however, a relationship between inflation and unemployment; that’s just not what Phillips observed. Unexpected inflation reduces unemployment; and that’s what drives our current economic winds.
Do me a favor.
If you run a cafe and notice that the prices for sausage rolls and soy lattes are increasing, or maybe you see that you have more customers than usual, a rational response is to increase your prices. Chances are some of your costs will go up, but others, like rent, salaries, and fixed rate debt, either don’t go up or are slow to go up.
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Your business seems more profitable. The sun is shining a little brighter. You can decide to hire a new server or finally invest in that pool that your long-suffering wife has wanted for many years. This translates into more people employed; either as servers or pool installers.
As time goes on, the rent goes up, wages match up with rising prices, and the mortgage goes up. You now understand that the extra profit was nominal. You might have more money at the end of each month, but that money only buys the same number of goods and services; because all the prices have gone up.
You will no longer be deceived. Higher incomes are not synonymous with higher prosperity if the costs also rise. It is true that the economy is benefiting from a temporary boom. After all, you now have a pool, and the increase in investment has resulted in new real economic activity. However, business owners quickly factor inflation into their calculations.
In this country, we have seen the rate of price increase go from less than two percent to five percent in one year. Unless you’re into hospitality or tourism, things look pretty good, and even in those industries the state has poured billions into keeping these operations alive. Bankruptcies this year are at record levels.
The economy is booming. Grant Robertson sings and makes predictions.
“Inflation is expected to peak in the March quarter of next year and then fall back over the remainder of 2022 to the Reserve Bank’s 2% midpoint over the remainder of the forecast period.”
It is an illusion; driven by our collective lack of institutional memory of what happened before. We feel richer. Real estate prices and the stock market are buoyant. Salaries have gone up. Price hikes mean businesses see more cash at the end of each month.
They will soon see through the conjurer’s deviation.
What is driving low unemployment and the current economic rush for methamphetamine are the unexpected price hikes. Robertson and Orr are working hard to convince us that inflation is transitory. It’s rational. For them. If businesses expect prices to rise 2.2% per quarter, as they did last time around, they will observe these changes and not change their employment and investment decisions.
But if you think that inflation is caused by shipping issues and a one-off hit from quantitative easing, you may be fooled by inflation and the virtuous circle described above will be engaged. It is the idea that economists such as Milton Friedman and others contributed to economic theory. In the long run, we’re all dead, and so is the Phillips Curve. There is no permanent compromise between inflation and employment.
Although it has been exhaustively debunked on several occasions, the Phillips Curve has lasting insight. If you can fool most people most of the time, you can generate short-term economic stimulus and win re-election and re-appointment as reserve bank governor.
Dr Phillips’ curve should be consigned to the Trinket Museum, alongside his MONIAC machine and the rubbish of degraded coins that make up the Reserve Bank museum, and not used as the basis for contemporary monetary policy.
* Damien Grant is an Auckland based business owner. He writes from a libertarian perspective and is a member of the Taxpayers Union but not of any political party.