Employment is at a record high in two-thirds of OECD countries. And still inflation is stubbornly low
economic models named after William Phillips is physical. The Phillips hydraulic computer uses flows of water to simulate flows of money in the economy; its success helped earn Phillips a job at the London School of Economics in 1950. Today economists can bring the full power of modern computing to their calculations. But they still depend utterly on another Phillips eponym: the curve tracing the relationship between inflation and unemployment .
This argument has some traction. In 2011, for example, a spike in commodities prices pushed inflation up but most central banks ignored it to focus on healing their scarred economies. Later in the decade, amid low unemployment rates, monetary policymakers became more attuned to the risk of overheating. It would be odd, however, to explain low inflation by appealing solely to deliberate choices on the part of central banks, when they themselves profess to be confused by inflation’s quiescence.
Where might such a threshold lie? Answering that question requires breaking the inflation puzzle into its constituent parts. First, to what extent are firms’ costs—most importantly, wages—rising? Second, are firms passing on those costs by raising prices? There are two ways to have wage inflation without price inflation. The first is a productivity boom, hitherto absent. The second is if firms’ profit margins fall. There is clear scope for lower margins in America, where since the mid-2000s firms have enjoyed profits, as a share of, that have been historically high. Profits have begun to come down in recent years as wage growth has risen.
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