THAT central banks cannot endlessly reduce unemployment without sparking inflation is economic gospel. It follows from “a substantial body of theory, informed by considerable historical evidence”, according to Janet Yellen, chair of the Federal Reserve. Her conviction explains why, on June 14th, the Fed raised interest rates by a quarter of a percentage point, to a range of 1-1.25%.
Excluding food and energy, prices are only 1.5% higher than a year ago; the Fed’s inflation target is 2%. But Ms Yellen thinks unemployment is below its so-called “natural” rate, so inflation should soon rise. Is she right? Or has the relationship between unemployment and inflation, dubbed the Phillips curve, gone missing?
It is not the first time the theory has failed. After the financial crisis unemployment soared to 10%. This surfeit of workers should have sent inflation tumbling. But prices held up well; in October 2009, when unemployment peaked, underlying inflation was 1.3%, only a little…
The Economist: Finance and economics
