Confused about why the Fed is still working to increase inflation despite the mixed signs of US economic recovery? Ok. Edward Price, a former British economic official and a political economy teacher at the Center for Global Affairs at New York University, explained the paradox at the core of the new monetary framework of the US Central Bank.

The physicist Erwin Schrödinger studied the smallest things. He found something strange. If observed, the atomic world will change its state. Schrödinger illustrated this idea with an imaginary cat. In the irradiated box, as long as the cat is kept out of sight, it can be both dead and alive. Only when the box is opened, its actual fate will happen.

This is ridiculous. Schrodinger himself admitted this. He hopes that his thought experiments can illustrate the absurdity of the views of other quantum scientists. However, in theory, it is almost ridiculous with some mainstream economics.

These include ideas at the core of the monetary policy maker model.

Take the Phillips curve. It has an inverse relationship between inflation and unemployment. In short, the more people working, the more money in the system. In turn, this should mean a higher inflation rate. For many years, the Phillips curve has been considered an economic science. But later, in the late 1960s, Milton Friedman savagely demolished the curve. He said that policy makers cannot rely on the trade-off between wages and prices, but inject inflation into a low unemployment rate, because workers will notice what they are doing and demand higher wages as a result. He believes that, eventually, inflation will exceed employment growth, which happened in the 1970s. In addition, the Phillips curve cannot explain situations where both inflation and unemployment are low, such as in the first quarter of 2020.

However, none of these shortcomings seem to really pull the inflation-employment trade off its golden base. This theory is still cited today, especially by central banks. For example, today, the market’s attention has been focused on non-agricultural employment data.These numbers are terrible, While the U.S. economy has only increased by about a quarter of the expected employment opportunities.

In light of concerns about the ability of the U.S. economy to recover, Fed Chairman Jay Powell made it clear that the Fed will provide support for a prosperous job market and subsequent inflation “as long as necessary.” At first glance, there is nothing wrong with this. According to the Fed’s contract with the government, it must produce two things: stable prices and full employment. However, at first glance, this authorization does not seem to match Friedman’s description of the Phillips curve. Full employment should lose stable prices, and vice versa.

To solve this problem, the Fed concocted two conceptual hackers.

The first is the non-accelerated rise of the unemployment rate (NAIRU). The AIR-speaking NAIRU just refers to the idea that in any stable currency system, some people will naturally not find a job. Conversely, there is no need to pursue full employment in the literal sense.

Another leeway comes from the equally playful definition of stable prices. The Fed and other central banks cannot pursue the stability of nominal prices. This will require a completely static monetary system to maintain a balance with a completely static economic system. This is impossible. Instead, it is best to gently remind you to go shopping-the actual purchasing power is declining, and inflation is small, which is the first choice.

However, the decline in actual purchasing power has largely made the central bank unavoidable. Although U3 is the most commonly used unemployment indicator, it has fallen to a level consistent with NAIRU.

This explains why the Fed abandoned the original framework last year and adopted Flexible average inflation target (FAIT), according to the regulations, it can tolerate inflation above the 2% target during the (unspecified) period. The purpose is twofold and simple. The inflation rate rises, and with it comes more work. In other words, if the inflation rate continues so low, then the concept of NAIRU must go.

This is where things get strange.

The proposed FAIT mechanics is an affirmation of Phillips curve theology. In other words, FAIT assumes that the curve is valid. Rising inflation will bring more job opportunities. However, at the same time, since the Phillips curve is dead, only FAIT can be used. Monetary policymakers killed it. If the inflation rate has been kept at a low level, then the monetary authority will not have the central bank daring to carry out deliberate and sustained inflation.

what is that? Is the Phillips curve alive or dead?

On the one hand, it’s still alive. Combining actual and proposed U.S. fiscal stimulus programs (estimated to account for nearly a quarter of U.S. GDP), the central bank may perform well in raising prices. On the other hand, it’s dead. Today’s non-agricultural figures are worrying. If it is concluded that we have been measuring the unemployment rate incorrectly, and for whatever reason, the inflation rate is still low, we can indeed say goodbye to NAIRU.

This is the problem at hand. The Fed’s position makes sense, because the natural unemployment rate suddenly becomes unknown.

For a long time, economists have been jealous of economists. They accused people of macroeconomic forecasts as reliable as physicists’ forecasts of natural phenomena. But the most compelling part of physics and economics has nothing to do with Newtonian mechanics. On the contrary, people are like atoms. When interacting with them, things always get strange. Macros cannot be inferred from the micro level, at least until the event occurs before they can be inferred. For mainstream equilibrium theory, this is a bitter red pill. However, it seems that the Fed has swallowed it, awakening from the dull scientific sleep to an unfamiliar reality.

Welcome to the weird and wonderful world of Quantum Central Bank.

Related Links
Farewell to the Fed’s forward guidance-FT Alphaville