Posted By: Margaret Pozzini

IbdTue Nov 14, 7:00 PM ET

Monetary Policy: When a powerful policymaker speaks his mind, it pays to listen -- especially when what is said might lead to a big mistake down the road.
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We thought about this after Richard Fisher, president of the Dallas Federal Reserve, noted Monday that skilled and even semiskilled workers seem to be in increasingly short supply throughout the country, pushing up wages.

"In Texas City," he told an economic think tank in San Antonio, "they were offering a welder in the oil patch $19 an hour at the beginning of the year. They're now offering $25 an hour, with a $100 show-up bonus ... and a completion bonus for your work."

Fisher is among those who seem to think this is a problem. He sees a worrisome link between more jobs, higher pay and rising inflation. We say, what's the problem?

Fisher's remarks stem from the common notion that the economy basically has just two buttons, which the Fed must push to come up with the perfect mix. One button is called "jobs." The other, "inflation." When one goes up, the idea goes, so must the other.

This idea -- called the Phillips curve in economics -- has entrenched itself at the Fed, in academia and on Wall Street. Fisher isn't alone in thinking this way, so it's a bit unfair to single him out. Even Fed chief Ben Bernanke seems to adhere to the notion.

Funny, but for six years now, we've been listening to nonstop complaints about the middle class being "squeezed" or unable to "keep up." Now that such workers are getting some long-overdue raises, it becomes a "problem." Sorry, we're not worried about this.

Let's look at the reality. The jobless rate is now 4.4%, about a 51/2-year low. Yet in October, core producer prices posted their biggest monthly drop in 13 years. And they rose just 0.6% from a year earlier, the smallest gain in three years.

Longer term, total compensation -- wages, salaries and benefits -- have jumped 29.9% since 1999. Core inflation is up 14.3%. That's called an improved standard of living, not inflation.

This underscores the Phillips curve's fatal flaw -- it doesn't reflect reality. Sometime back in the 1970s, it became obvious that the underlying idea -- that the Fed could "buy" more jobs by letting inflation rise -- no longer worked. We had higher inflation and higher unemployment. Then, in the 1980s and 1990s, the exact reverse took place -- the economy boomed, job growth soared and inflation fell.

As such, it's pretty clear the Phillips curve is defunct. In recent years, some have tried to revive it using various statistical tricks. Inflation and employment have a tenuous link at best.

Yet though the idea of the Phillips curve is one of the most debunked in modern economics -- at least two Nobel Prizes have been awarded for work that attacked its basic premises -- it's harder to kill off than a vampire in a B-grade horror flick.

As famed economist John Maynard Keynes noted more than 60 years ago: "Practical men, who believe themselves to be quite exempt from any intellectual influences, are usually the slaves of some defunct economist."

Ironically, in this case, the defunct economist is Keynes himself -- whose economic theories gave credence to the Phillips curve. Even today, the Fed is apt to use the curve, or something like it, to make a case for keeping interest rates high. Some might even think it makes the case for a rate hike.

This would be a grave error. Inflation results only when the Fed prints too much money for the economy to productively use, not when people get jobs. After 17 consecutive interest hikes lasting two years, the Fed has stopped. With money supply growing modestly, the Fed should definitively take rate hikes off the table.

Meanwhile, if you're worried about the economy, we can keep noninflationary growth going through wise policies. What would those be? Some -- like lower taxes on income, profit and capital, and productivity enhancing investments in education and training -- are in place. Others, such as free trade, have sadly fallen out of favor with a new Democratic Congress.

So don't worry, Mr. Fisher, about those labor shortages. Workers will show up. If they're getting paid more, it's not a bad thing -- it's not called the labor market for nothing.

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