Death of the Phillips curve brings political foes together at the graveside
Incongruous does not even begin to capture the sudden outbreak of harmony between President Donald Trump’s economic policy adviser and a star of the Democratic party’s left wing.
Larry Kudlow, director of the White House’s National Economic Council, offered effusive praise last week to Alexandria Ocasio-Cortez, the Democratic congresswoman who has inspired a mass following among the younger and more leftwing ranks of her party, after her quizzing of Jay Powell, Federal Reserve chair, in Congress.
She asked Mr Powell about how the Phillips curve — the relationship between inflation and unemployment — seemed to have vanished over time. Mr Powell confirmed there was at most “a faint heartbeat” of inflationary pressures from tight labour markets, measured by unemployment rates that have long been below the “sustainable” levels estimated by the Fed. That allowed the congresswoman to suggest that more stimulative monetary policy is safer today than may have been thought in the past.
Mr Kudlow was enraptured. ““She got it right,” he reportedly gushed, congratulating her on getting the Fed chair to confirm “that the Phillips curve is dead”. He predicted that “the Fed is going to lower interest rates” and expressed a desire to discuss policy with her soon.
It would be churlish not to accept these crumbs of comity in a political environment that usually offers anything but that. (In a clear, but erroneous, reference to Ms Ocasio-Cortez, who is a US-born citizen, Mr Trump said in a tweet this week that “Progressive Democrat Congresswomen” should “go back and help fix the totally broken and crime infested places from which they came”.)
However, an understanding between Trumpist Republicans and Ms Ocasio-Cortez Democrats over more dovish macroeconomic policy may be too good to be true. Any convergence between them over the direction of policy risks being grounded in wildly diverging theories of how the economy works, both probably wrong.
Mr Kudlow is part of the priesthood of supply-side economics — the idea that deficits caused by tax cuts do not matter, because the additional growth they create will make up for the lost revenue. It first became influential in the 1980s to justify Ronald Reagan’s huge tax cuts and was linked to Art Laffer’s eponymous curve showing how lower taxes (supposedly) meant higher tax income. It has since resurfaced whenever Republicans retake the White House: Mr Trump awarded the Presidential Medal of Freedom to Mr Laffer earlier this year.
Each time it is put into practice, however, supply-siders show little concern when the prediction of greater tax revenues is not borne out. As Dick Cheney said in 2002, Reagan proved that voters will not punish Republicans in power for deficits they denounce in opposition. For Mr Kudlow, the appeal of the Phillips curve’s death is presumably the implication that the Fed can juice the economy even as the Trump tax cuts start to weigh on public finances.
In contrast, Ms Ocasio-Cortez is circumspect in her economic theorising. She has not laid out her own detailed thinking about why the Phillips curve has weakened and what, exactly, that means for policy. In particular, she has not drawn an implication in favour of bigger fiscal deficits, as opposed to her perfectly fiscally conservative position of funding public spending increases with higher taxes.
But she has given a nod to another eccentric analysis of the economy. Modern monetary theory, which Ms Ocasio-Cortez has said should be “part of our conversation”, shares with supply-siders the view that public deficits and debt need not be a constraint on government budgets so long as inflation is quiescent — though MMTers want to unconstrain higher spending rather than tax cuts.
This view, too, is built on murky foundations, including the notion that the government creates money when it spends (in fact most money is created when private banks issue loans by crediting customers’ deposit accounts) and therefore does not need to finance its deficits through borrowing.
The reason why both supply-side economics and MMT are viewed with scepticism is that they too often sound like they ignore the existence of real resource constraints in the economy. If, instead, all they mean to say is that macroeconomic policy should stimulate economic activity until we exhaust any unused resources, then there is no disagreement with standard Keynesianism — Mr Powell would presumably agree — but also no need for an alternative theory. Instead, the key is pinpointing when the economy is using its resources to the full — something policymakers have badly underestimated recently, and not just in the US.
Just as two wrongs do not make a right, two voodoo theories typically do not make for a sound conclusion. But if an entente between Mr Kudlow and Ms Ocasio-Cortez — even on conflicting and questionable grounds — popularises the view that the US and other economies can take more stimulus in their stride, we should count it as enlightened policymaking by today’s standards.