105 – David Andolfatto on Inflation and the Phillips Curve

Episode Summary

Executive Summary: The episode debates why U.S. inflation persistently undershot the Fed’s 2% target despite falling unemployment. David Andelfatto argues the Phillips curve has flattened or become unreliable, and that broader money-demand factors—especially demand for safe assets like Treasuries—better explain low inflation. The conversation ends with policy caution: don’t tighten too quickly based on a shaky Phillips-curve story.

Main Topics: The inflation puzzle and the Phillips curve (Priority: 5/5): The host frames the post-crisis period as a mystery: unemployment fell sharply, yet inflation stayed below target. Andelfatto explains the conventional Phillips-curve logic and why it predicts rising inflation at low unemployment, but notes that this relationship has not been visible in recent years. Why the Phillips curve may be failing (Priority: 5/5): Several explanations are discussed: a lower natural rate of unemployment, a flatter Phillips curve at low inflation, and declining labor bargaining power. Andelfatto is skeptical of these fixes, arguing they mostly preserve the Phillips-curve framework without fully explaining the data. Broader money-supply and money-demand view of inflation (Priority: 5/5): Andelfatto proposes viewing inflation through a wider monetarist lens, where Treasury securities and dollars function as safe monetary assets. Low inflation is explained by strong demand for these assets relative to supply, not just labor-market slack. Safe assets, Treasury demand, and global disinflation (Priority: 4/5): The discussion emphasizes that foreign and domestic demand for U.S. Treasuries and dollars rose after the crisis, while supply growth slowed. This excess demand for safe assets is presented as a disinflationary force independent of unemployment. Fiscal policy, debt, and inflation expectations (Priority: 4/5): The conversation expands into fiscal theory: current and expected future debt monetization can affect money demand, velocity, and inflation. The idea is that fiscal conditions matter both contemporaneously and through expectations. Krugman, ‘immaculate inflation,’ and microfoundations (Priority: 4/5): Paul Krugman’s critique is addressed: wage/price setters respond to slack, not money demand. Andelfatto replies that money-demand and slack are two sides of the same coin and that portfolio rebalancing provides a microeconomic mechanism for monetary effects. Policy implications for the Fed (Priority: 5/5): The episode closes with caution against aggressive rate hikes based on an overconfident Phillips-curve interpretation. Andelfatto suggests policymakers should adopt a broader framework and remain data-dependent, especially when inflation is still below target.

Key Arguments: Inflation has remained below the Fed’s target for years even as unemployment fell, which weakens simple Phillips-curve predictions. One conventional response is to say the natural rate of unemployment fell or the Phillips curve flattened, but these are ad hoc fixes if not supported by evidence. A broader measure of money should include safe assets such as U.S. Treasuries, not just narrow monetary aggregates. Strong global demand for Treasuries and dollars after the crisis likely reduced inflationary pressure by raising money demand relative to supply. Fiscal policy matters because debt issuance, debt monetization, and expectations of future monetization affect inflation and velocity. Money-demand shocks and slack in the economy are two perspectives on the same underlying portfolio-rebalancing process. The Fed should avoid tightening too aggressively when inflation remains subdued and the causal model is uncertain. Macro disagreement is often overstated; many economists share policy goals even if they emphasize different transmission channels.

Data Points: Headline PCE inflation average since recovery: 1.4% - Average inflation rate since the post-2009 recovery, cited as persistently below the Fed’s 2% target. Core PCE inflation average since recovery: 1.5% - Average core inflation rate over the same period, also below target. Fed inflation target: 2% - Official PCE inflation target discussed throughout the episode. Unemployment rate peak during crisis: 10% - Referenced as the high point before falling during the recovery. Unemployment rate in the discussion period: 4.1% - Very low by historical standards, yet inflation remained subdued. Fed’s peg at the effective lower bound: 25 basis points - Used as an example of the low-rate environment during the recovery. 10-year Treasury yield: 2.9% - Presented as evidence that demand for safe assets remained elevated relative to pre-crisis levels. Pre-crisis 10-year Treasury yield: above 5% - Used as a comparison to show how low yields remained after the crisis. Core PCE inflation recent month: 1.6% - Mentioned late in the discussion as inflation still below target despite deficit expansion. Inflation in FDR episode (WPI): above 20% - Scott Sumner’s historical example of rapid inflation following revaluation/devaluation policy in 1933. Unemployment in FDR episode: near 25% - Used to illustrate that inflation can jump even amid massive slack when expectations change.

Pivotal Quotes: "There exists a so-called natural rate of unemployment and a Phillips curve relationship, which is a negative relationship between either wage or price inflation and the rate of unemployment." — David Andelfatto: Explaining the conventional Phillips-curve framework at the start of the interview. "I want to say that, first of all, ... one can just simply make reference to the notion that the natural rate tends to vary over time. So it's not a puzzle from that perspective." — David Andelfatto: Arguing that the inflation puzzle disappears if the natural unemployment rate is allowed to move. "If it is true that it is the unemployment rate being below the natural rate that generates inflation, and that monetary factors don't play a role, then there's an obvious policy conclusion here that the Fed should just basically set the nominal interest rate to zero." — David Andelfatto: Responding to critics by showing the absurd implication of a pure Phillips-curve view.

Implications: The episode suggests inflation analysis should go beyond labor-market slack and include safe-asset demand, fiscal conditions, and portfolio behavior. For policymakers, that means more caution about rate hikes and more attention to broader monetary dynamics.