Expert Commentary

Ah, Professor Phillipps, I Presume?

Phillips has not gone missing after all.

David Livingstone was a Scottish physician, pioneer Christian missionary, an explorer in Africa, and one of the most popular British heroes of the late 19th-century Victorian era. In Africa, Livingstone completely lost contact with the outside world for six years and Henry Morton Stanley was sent to find him by the New York Herald newspaper in 1869. After searching for this needle in a haystack, he finally found Livingstone in the town of Ujiji, in modern day Tanzania, on the shores of Lake Tanganyika on 10 November 1871, greeting him with the now famous words, "Dr Livingstone, I presume?" A recent paper by the European Central Bank made me think of this legendary story.

You see, researchers at the ECB have discovered that the Phillips curve, named after economist William Phillips, far from being missing over the past few years as most people have assumed, has actually been alive and well, although hidden from view. The Phillips curve is the relationship between employment and price inflation, with price inflation expected to rise as employment does. However, that dynamic has been subdued in recent years, leading the ECB, among many, to believe that the relationship had broken down.

In the paper, the researchers examined "core" price growth although they didn't use the ECB's preferred measurement of price inflation that strips out food and energy. Instead, they analyzed the weighted median of all industries' price inflation rates arguing that it produces a less-volatile gauge. The paper concluded that using such a measurement, "a simple Phillips curve captures most of the movements in inflation over the 20 years that the euro has existed."

Such a revelation may well influence the ECB's monetary policy strategy. Up until now, the presumed absence of the Phillips curve has encouraged radical policies such as Quantitative Easing and persisting with negative interest rates. If, indeed, Phillips is alive and well, the ECB might steer back to a more conventional path. What that means for markets is, of course, irrelevant as they follow Elliott waves but it might mean that the ECB is perceived as being a little less dovish.

200114 - MG