The Path Of The 'Phillips Curve' Since The Beginning Of The Financial Crisis [Chart]

Currently the Federal Reserve is using unemployment rate and inflation rate thresholds to guide monetary policy. Specifically, the Fed says it expects to keep monetary policy easy as long as the unemployment rate is above 6.5 percent and the inflation rate is below 2.5 percent.

In a presentation given at the Global Interdependence Center conference in Dubai, David Kotok of Cumberland Advisors presented a chart tracking the Phillips curve (Simply put, the Phillips curve is the relationship between unemployment and inflation. According to the theory, a low unemployment rate is correlated with a higher rate of inflation.)

As you can see, the path has been quite volatile. Some attribute the surge in energy prices as tipping the economy into recession in late 2007, which would explain the lower right corner of the chart. And as unemployment rose, prices fell, which is in line with the Phillips curve theory.

And while curve is much closer to the Fed's threshold, it still has a ways to go.

Here's Kotok's commentary:

Slide 12 tracks the Phillips curve, or inverse relationship between the unemployment rate and inflation rate. The concept was introduced to me by Thomas Synnott, a colleague at the National Business Economic Issues Council (NBEIC). Synnott uses the tracking system shown, with monthly data points. He describes it as an “under-damped oscillatory system.” The idea is to show the difference in shifts in duration, slope, and composition of the Phillips curve. One can see the pre-crisis levels in blue, the shift during the crisis in red, and the current green expansion period, through February 2013. The Fed’s target is marked with an “X.” Clearly there is a large gap between the current situation, in February 2013, and the Fed’s targets of 6.5 percent for the U3 unemployment rate and 2.5 percent for the inflation rate. Again, if we were to use the U6 in this curve instead of the U3, the gaps would be much more extreme.