James Hamilton Estimates a Phillips Curve
By Arnold Kling
the forecast of the model for the average inflation rate between 2009:Q4 and 2011:Q4 is -0.5%.
…If for further evidence on inflationary expectations you looked at the gap in yields between nominal Treasuries and TIPS, you’d say inflation expectations remain quite low– currently the 10-year spread corresponds to an average annual inflation rate under 2% for the next decade.
Read his whole post, particularly if you are an undergraduate student of macroeconomics.
Implicit in his equation is the assumption that the NAIRU (the non-accelerating-inflation rate of unemployment) has been constant from 1948 until today. I doubt that is the case. My guess is that the NAIRU rose during the 1970’s, to the surprise of policy makers. It then fell during the Great Moderation, again to the surprise of policy makers.
My guess is that it has risen again following the financial crisis. The unemployed construction workers are not going to put as much downward pressure on faculty salaries, or on the cost of health care, as Hamilton’s Phillips Curve would imply.
I am much more bearish than the market on the outlook for inflation, and I am betting that way, in the sense that my portfolio is skewed in that direction. (Note Robin Hanson on why finance professors do not bet.) I think that while the economy is Recalculating, the NAIRU will be unusually high, so that over the next few years inflation will stay positive. Once the market figures out where to put people back to work, the overhang of government debt will produce a lot more inflation than an average of 2 percent over the next decade.