The Fed and the Phillips Curve

According to Wikipedia, the Phillips curve is a historical inverse relationship between rates of unemployment and corresponding rates of inflation.  Theoretically, reductions in the unemployment rate should cause prospective employers to offer higher wages which, under some circumstances, can have an inflationary effect.

Clearly, the Fed looks at a wide range of metrics in determining the timing of changes in interest rates.  Primary concerns include unemployment and inflation.  Currently, the data is somewhat confusing.

Inflation is probably lower than might be expected, considering the amount of deficit spending, perhaps due, at least in part, to sharp declines in commodity and energy prices.

The unemployment rate of approximately 5% does, at first glance, appear to be inconsistent with very low labor force participation.  There do not appear to be any substantial shortages in the workforce, except for specific skills and geographic mismatches.  In other words, employers seem to be able to fill job openings, at current wage rates, where specific skills are not a material factor.

When the data you are using does not match the expected result, it might make sense to review data collection.  Have the major changes in telephone technology, over the last several years, affected survey techniques and results?  Have regulatory and safety net changes altered the way people relate to employment?

Both the Fed and investors would be well advised to be careful in relying on historical data points in a rapidly changing environment.

All comments and suggestions are welcome.

Walter J. Kirchberger, CFA®