Is economists' favorite tool to crush inflation broken?

Episode Summary

Executive Summary: The episode traces how Bill Phillips, an engineer-turned-economist, used a water-flow machine and historical data to identify a relationship between unemployment and inflation that became the Phillips curve. It then follows how Milton Friedman exposed its limits, how economists rebuilt it, and why the curve’s rise and fall shaped central banking—and public assumptions about inflation fighting.

Main Topics: Bill Phillips’ unusual path into economics (Priority: 5/5): Phillips was a New Zealand-born engineer, crocodile hunter, and tinkerer who entered economics after WWII and became known for treating the economy like a machine that could be modeled and controlled. The water-flow machine as an economic model (Priority: 4/5): Phillips built a physical hydraulic model of the economy, using tanks, pipes, and levers to represent sectors and policy tools, which helped convince skeptics at the London School of Economics. The original Phillips curve (Priority: 5/5): Using a century of UK wage and unemployment data, Phillips found an inverse relationship: low unemployment tended to coincide with rising wages/inflation, while high unemployment coincided with low inflation. Mainstream adoption and policy optimism (Priority: 5/5): Economists like Paul Samuelson popularized the curve, and policymakers in the 1960s used it as a guide for managing the economy, believing they could choose a tolerable trade-off between inflation and unemployment. Friedman’s critique and stagflation (Priority: 5/5): Milton Friedman argued the curve was too simple because it ignored inflation expectations and other dynamics; the 1970s stagflation episode seemed to confirm his warning. Phillips curve 2.0 and the Fed (Priority: 4/5): Economists updated the curve to include expectations, supply shocks, and the natural rate of unemployment; Alan Blinder later used this framework at the Fed to pursue a 1994-95 soft landing. Why the curve matters less today (Priority: 5/5): Decades of low and stable inflation despite large labor-market swings weakened confidence in the Phillips curve, suggesting economists still lack a stable universal law for inflation dynamics.

Key Arguments: Bill Phillips helped transform macroeconomics from intuition into empirical, testable relationships by building physical and statistical models. The original Phillips curve suggested a trade-off: lower unemployment often came with higher inflation, giving policymakers a potential control knob. Milton Friedman’s expectations-based critique showed that the relationship was not stable over time and would break down if people adapted their expectations. The 1970s stagflation episode—high inflation and high unemployment simultaneously—demonstrated that the simple Phillips curve failed in the real world. Economists responded by making the curve more complex, adding expectations, supply shocks, and the natural rate of unemployment. Alan Blinder’s 1994 Fed experience showed the updated framework could still guide policy toward a soft landing, though he later lost faith in its predictive power. The broader lesson is that economies are dynamic systems made of people who react to policy, so economic “laws” are much harder to pin down than physical laws.

Data Points: Birth year of Bill Phillips: 1914 - Phillips was born in New Zealand in 1914. Time period of Phillips’ main work: Early 1950s - He developed the water-flow model and the unemployment-inflation insight during the early postwar macroeconomics era. Historical data used: About 100 years - The data set that helped Phillips identify the curve included roughly a century of UK wage and unemployment records. Academic milestone: 1961 - Paul Samuelson put the Phillips curve into his textbook in 1961, helping mainstream it. Conference speech year: 1967 - Milton Friedman’s critique was delivered at the American Economics Association conference in 1967. Federal Reserve job year: 1994 - Alan Blinder became vice chair of the Federal Reserve in 1994. Soft landing period: About a year - Blinder said the Fed continued rate hikes for about a year and achieved a soft landing. Duration of low inflation: Late 1990s to around 2022 - Blinder noted inflation stayed broadly stable for decades, despite major swings in unemployment.

Pivotal Quotes: "He went home in his garage, he built the famous machine, which was a water flow model of how the economy behaved." — Willa Rubin / Richard Lipsy: Describing Phillips’ hands-on approach to understanding macroeconomics through a physical model. "But the idea that the Phillips curve precisely maps out a stable relationship between unemployment and inflation, one that'll hold up in the long term? No way." — Milton Friedman: Friedman’s 1967 critique of the original Phillips curve. "If you don't understand what's driving inflation up or down, you've lost an important tool and you're wandering a little bit in the forest when it comes to predicting inflation." — Alan Blinder: Blinder explaining why the Phillips curve mattered for central banking, even though it later proved unreliable.

Implications: The episode shows why inflation policy is hard: relationships that seem stable can change as people and institutions adapt. Policymakers still need models, but should treat them as guides, not laws.