Is the Phillips Curve still relevant?

             

              Alice Kantor on Dec 21st 2013

      The 1958 Phillips curve establishes a negative connection between the rate of inflation and the rate of unemployment. It supports the idea that a low level of unemployment allows for employees to ask for higher wages (they do not fear unemployment), which subsequently increases the pace of the rising of general prices. The Phillips curve represents this trade-off between unemployment and inflation.

In the 1960s, an estimate of the curve seemed to correctly encapsulate the functioning of the job market. Today, it does not seem to be the case anymore.

A time series analysis of the periods between 1998 and 2012 enables us to draw the Phillips curve of the last decade. From then on, we can demonstrate that there is no clear connection between unemployment and inflation in that time period.

For this analysis, we first adjusted the figures of inflation, so as to neutralize seasonal variations. We devised a code in the SAS (Statistical Analysis System) programming software, which helped us achieve that goal. We obtained an ascending linear line, representing the evolution of the rate of inflation between 1998 and 2012.

We then proceeded to a cross analysis, relating unemployment to inflation. This led us to a curve, showing the combined evolution of unemployment and inflation between 1998 and 2012. Finally, data analysis was conclusive in the exhibition of a long-term rate of unemployment.

 Theoretic Phillips Curve

                                             Methodology

We have used the macro-economic data set of the INSEE (National Institute of Statistics and Economic Studies), updated on 12/12/12. We have called on the specific rates of unemployment of metropolitan France from 1998 to 2012, as recorded by the INSEE, in keeping with the ILB (International Labor Bureau) definition of unemployment and with European standards. French local regional surveys have been generalized to a national scaled study. In order to have an estimate of the rate of inflation, we have chosen a consumer price index based on all goods and services of households from metropolitan France between 1998 and 2012. The index has been adjusted and is recorded in a 1998 base-100. The records on rates of inflation are given per month. In order to compare the set of  data about unemployment given per quarter, we have calculated the average of the rate of inflation per quarter. Our analysis starts in 1998 because a big enough set of data is necessary to give an accurate estimate of the Phillips curve and to establish if there is a link of correlation between unemployment and inflation. Horizontal lines report cut-off points of the curve.

Phillips Curve between 1998 and 2012

Rate of unemployment (%)

      

         A quick comparison with the theoretic curve shows no sign of a Phillips curve in the 1998-2012 periods. However, we can consider the curve from 1998 to 2001, as well as the one from 2005 to 2008, as short-term Phillips curves. They demonstrate gradual shifts to the right of the original curve, which some economists like Edmund Phelps have explained as the effect of inflationary expectations. 

Variables	Number of Observations	Mean	Standard deviation	Minimum	Maximum
Unemployment rate	60	8.85	0.88	7.1	10.7
Inflation rate	60	112.19	8.39	99.7	126.44

Standard deviation of the 60 observations of unemployment is only 0.88. We are therefore inclined to condone Milton Friedman’s claim about a “natural” rate of unemployment. The natural rate is defined in The Optimum Quantity of Money as a stable rate, not affected by inflationary expectations, around which cyclical unemployment revolves. From our data analysis, we would argue that the natural rate of unemployment over the past 14 years in France is the average rate of 8.85%.

Finally, between 2001 and 2005, and between 2008 and 2012, we observe the combination of high rates of inflation (a 26% increase in 2012, from 1998), and high rates of unemployment (9.7% unemployment rate in 2012), a phenomenon labeled in the 1970s as “stagflation”.

The Phillips relationship is not a valid way to gauge today’s complex ties between rate of inflation and rate of unemployment in France. However, Friedman’s allegations about a long-term unemployment rate are vindicated by the data we have analyzed. Structural unemployment in France would revolve around 8.9%, a rather high level of unemployment for a government-intervening market.