Cochrane and the Phillips Curve
2025 05 31
John Cochrane at Resurrecting the Lucas Phillips Curve develops a model (when none he says has existed before) that reproduces the mechanisms of the standard New Keynesian relation relating, interest rates, output/employment, and inflation.
“In the standard beliefs, higher interest rates depress aggregate demand, that depresses output and employment, and via the Phillips curve, that depresses inflation, and all of this happens slowly over time, with “long and variable lags.”
I have to believe that Cochrane knows better than I what standard beliefs are, but standard or not, this seem wrong in three ways.
First, what is the starting point for the analysis? Is it a multi-good, multi- sector, multi-input, multi-relative price economy in dynamic equilibrium: real income growing at the maximum given resource constraints at the optimum rate of inflation (the minimum rate that permits a multisector economy to react to an average level and frequency of real and nominal positive and negative “Brownian” shocks, permitting relative prices to adjust and all sectoral market to clear so that real growth IS at a maximum)?
Second, in such an economy would not a central bank-engineered increase in interest rates first depress inflation which would inhibit adjustment to Brownian shocks, lead to some markets not clearing, and depress real output and employment? This would not be “via” a Phillips curve but a description of a movement from higher to lower inflation and lower to higher unemployment that looks like a “Phillips Curve” although with the causation going from inflation to real output and inflation not viceversa.
Third, the model being discussed has a Taylor rule for interest rate targeting rather than inflation targeting which is what central banks presumably do.
So I’m totally confused. Clearly I don’t know where Cochrane is going with all this and would probably not be able to follow him if I intuited it.
In case I’m not the only one, can a reader help us out?
Image Prompt: Bewildered man (Why the street scene????)
[Standard bleg: Although my style is know-it-all-ism, I am aware that I could be mistaken or overstate my points. I would, therefore, welcome comments on these views.]
Thomas,
I’m fine with your self-claimed style of “know-it-all’ism.”
You clearly show some humility when you indicate your confusion on Cochrane’s approach and ask for help in understanding what appear to be contradictions. Sorry to say I won’t be the one to help clarify. You mostly left me in the dust with this post of yours. I majored in chemical engineering with a minor in economics over 50 years ago. I clearly need to brush up on my economics, and more recent terminology and theory. That said, I still enjoy being exposed to and considering the implications of various economic theories and arguments. Looking forward to your future posts.
Bill S.
We haven't had a "recession" cos we've had high immigration for decades -- but we've had a number of PER CAPITA RECESSIONS. But only a few people talk about those.