January 1, 2015

NAIRU, wage-led growth, and Samuelson's Dyscalculia

Comment on 'NAIRU theory — closer to religion than science'

Blog-Reference

The original Phillips curve was about the relation of the rate of unemployment and the rate of change of the wage rate (Phillips, 1958). Phillips studied more than a century's worth of data and established the stable inverse relation for the United Kingdom. Phillips's original curve was a remarkable empirical finding. It has to be emphasized that Phillips ‘had not made an explicit link between inflation and unemployment’ (Ormerod, 1994, p. 120).

The original curve was transformed by Samuelson with the simple formula: rate of inflation = rate of wage growth - rate of productivity growth (Samuelson and Nordhaus, 1998, p. 590). This formula, according to Samuelson an ‘important piece of inflation arithmetic’, says that price inflation runs in tandem with wage inflation and that both have basically the same effect on employment respectively the rate of unemployment. The difference between the original and the bastard Phillips curve consisted of a 1 percent productivity growth. This naive calculation led to the far-reaching policy conclusion that there exists an exploitable trade-off between inflation and unemployment.

Needless to say that this basic version experienced refinement, reinterpretation, and qualification in the sequel. It was completely overlooked in the ensuing filibuster, though, that, to begin with, Samuelson's arithmetic was fallacious.

The problem, however, runs much deeper. The Phillips curve has always been discussed in terms of supply-demand-equilibrium on the labor market as if this were a correct formal representation. Things became worse with the introduction of expectations.

Fundamental to the Phillips curve discussion are a host of behavioral assumptions. What has been overlooked is that the monetary economy has some objective structural properties. Whatever the agents think, plan, expect, or do, they cannot incapacitate structural laws.

The structural law takes the form of a structural Phillips curve (2012, eq. (33)) which says:
• An increase of the wage rate leads to higher employment, i.e. to a lower unemployment rate. This is in accordance with the correlation of Phillips's original study.
• A price increase is conducive to lower employment. This is in discordance with the Samuelson-Solow version of the Phillips curve, that is, with the trade-off between unemployment and inflation. The stagflation of the 1970s is generally seen as an empirical refutation of the neoclassical synthesis version of the Phillips curve. This refutation of ‘perverted’ Keynesian economics (Davidson, 2009, pp. 18-20) indirectly corroborates the structural Phillips curve which explicitly predicts stagflation.
• Provided that wage rate, price and distributed profit all change with the same rate (between zero and infinite percent in the simplified case) there is no effect on employment at all. This is in accordance with the NAIRU and rational expectations interpretation of the Phillips curve, i.e. in this cases the Phillips curve is vertical. The structural Phillips curve explains verticality without recourse to expectations (rational or otherwise) or any other behavioral assumption.

Behavioral assumptions are always beaten by structural laws. NAIRU is not close to religion, it is close to scientific junk.

Egmont Kakarot-Handtke


References
Davidson, P. (2009). The Keynes Solution. The Path to Global Economic Prosperity. New York, NY: Palgrave Macmillan.
Kakarot-Handtke, E. (2012). Keynes’s Employment Function and the Gratuitous Phillips Curve Disaster. SSRN Working Paper Series, 2130421: 1–19. URL
Ormerod, P. (1994). The Death of Economics. London: Faber and Faber.
Phillips, A. W. (1958). The Relation Between Unemployment and the Rate of Change of Money Wage Rates in the United Kingdom, 1861-1957. Economica, 25: 283–299. URL
Samuelson, P. A., and Nordhaus, W. D. (1998). Economics. Boston, MA, Burr Ridge, IL, etc.: Irwin, McGraw-Hill, 16th edition.


See also on Lars Syll's blog here and here for wage-led growth and 'NAIRU: an exhaustive dancing-angels-on-a-pinpoint blather' and cross-references Employment