July 26, 2015

The end of storytelling

Comment on Simon Wren-Lewis on ‘The F story about the Great Inflation’

Blog-Reference

“In order to tell the politicians and practitioners something about causes and best means, the economist needs the true theory or else he has not much more to offer than educated common sense or his personal opinion.” (Stigum, 1991, p. 30)

Because economists have been aware at least since the 1930s that they lack the true theory they let a change of rules happen. The true/false criterion of science vanished and had been replaced by the first rule of communication: “A good principles of economics teacher is a good storyteller.” (Colander, 1995, p. 169)

This is how economics eventually became a sitcom.

This blog makes no exception. Already the third sentence of the intro is incorrect. You write: “After Phillips discovered his curve, which relates inflation to unemployment, ...” 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 bastardized by Samuelson with the formula: rate of inflation = rate of wage growth minus rate of productivity growth (Samuelson and Nordhaus, 1998, p. 590). This ‘important piece of inflation arithmetic’ was fallacious but this did not prevent the acceptance of the Samuelson/Solow ‘Phillips’ curve. Phillips is said to have remarked ‘if I had known what they would do with the graph I would never have drawn it.’ (Quiggin, 2010, p. 91).

The storytelling then continued with Friedman and the vacuous filibuster about expectations and the natural rate of unemployment.

The correct Phillips curve is given here.

This testable structural curve asserts inter alia (2012, Sec. 7):
• An increase of the average wage rate leads to a lower unemployment rate. This is in accordance with the correlation of Phillips's original study, but clearly against conventional labor market wisdom (2015).
• A price increase is conducive to lower employment. This is in accordance with the stagflation of the 1970s.

The structural Phillips curve contains vastly more variables than the methodologically inferior bastard versions. All that has to be done is to stop storytelling and to check how data and formula fit together. Time to make economics a science.

Egmont Kakarot-Handtke


References
Colander, D. (1995). The Stories We Tell: A Reconstruction of AS/AD Analysis. Journal of Economic Perspectives, 9(3): 169–188. URL
Kakarot-Handtke, E. (2012). Keynes’s Employment Function and the Gratuitous Phillips Curve Disaster. SSRN Working Paper Series, 2130421: 1–19. URL
Kakarot-Handtke, E. (2015). Major Defects of the Market Economy. SSRN Working Paper Series, 2624350: 1–40. URL
Ormerod, P. (1994). The Death of Economics. London: Faber and Faber.
Quiggin, J. (2010). Zombie Economics. How Dead Ideas Still Walk Among Us. Princeton, NJ, Oxford: Princeton University Press.
Samuelson, P. A., and Nordhaus, W. D. (1998). Economics. Boston, MA, Burr Ridge, IL, etc.: Irwin, McGraw-Hill, 16th edition.
Stigum, B. P. (1991). Toward a Formal Science of Economics: The Axiomatic Method in Economics and Econometrics. Cambridge, MA: MIT Press.