The Phillips curve doesn't predict inflation
By Scott Sumner
I’ve done a number of posts pointing to the folly of using the Phillips curve to predict inflation in the US. People are making the same mistake in Japan, assuming that a stronger labor market will lead to higher inflation:
The Bank of Japan’s nine-member board will seek to explain why the strength in the economy has yet to translate into inflation, a dilemma they are struggling with as wages and prices remain stubbornly weak, say sources familiar with its thinking.
“Given the economy is in such a good shape, it’s hard to explain why inflation remains so weak. This will be among key topics of debate at this month’s BOJ meeting,” said one of the sources, a view echoed by two other sources.
Actually, it’s not at all hard to explain. Nominal GDP growth in Japan remains very weak, and that’s what is leading to low inflation. Monetary policy is too tight
Many Keynesians get the Phillips curve backwards. They think that real changes (such as lower unemployment) have nominal consequences (higher inflation.) Milton Friedman saw things differently. Unexpected changes in nominal variables (inflation) cause real effects (unemployment.) I think he’s basically correct, although I’d replace inflation with NGDP growth.
Don’t use real variables to predict nominal variables.