August 18, 2015

Nine views are nine too much

Comment on Brad DeLong on ‘Forder: Nine View of the Phillips Curve’

Blog-Reference

The history of economic thought tells us that economic methodology consists in kicking the can down the road until all gets stuck in the morass of multiplicity, inconclusiveness, and confusion.

The Phillips curve debate is a case in point. Forder concludes his paper: “There was no clear meaning attaching to the expression ‘Phillips curve’ and consequently, nothing much could be said to be definitely true or false of it.” And “A further point is that anyone — very nearly anyone — could find some kind of ‘Phillips curve’ of which they approved, or could use in analysis, or could fit into a model.”

The compulsive drive to push every issue to the point of inconclusiveness and anything-goes is so characteristic of economics that it deserves its own label. Let us call it the Hicks drive. "As far as I can make out, there are relevant and important senses in which all these statements are each of them right and each of them wrong.” (Hicks, 1939, p. 184)*

This is the natural end of every economic debate. For lack of the true theory, this is all economists have to offer. “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)

The Phillips curve is part and parcel of employment theory (2012). Conventional employment theory is a failure. To make a long argument short, the most elementary version of the correct employment equation is given here.

From this equation follows inter alia:
(i) An increase of the expenditure ratio rhoE leads to higher employment. An expenditure ratio rhoE>1 indicates credit expansion, a ratio rhoE<1 indicates credit contraction/debt repayment.
(ii) Increasing investment expenditures I exert a positive influence on employment, a slowdown of growth does the opposite.
(iii) An increase of the factor cost ratio rhoF=W/PR leads to higher employment. This implies that a higher average wage rate W leads to higher employment. This explains the original Phillips curve.
(iv) A price increase lowers the factor cost ratio and is conducive to lower employment. This explains stagflation.
(v) The complete employment equation is a bit longer and contains in addition profit distribution, public deficit spending, and the trade balance with the rest of the world. All variables are measurable, the structural employment equation is testable.

Point (i) and (ii) is familiar Keynesian stuff. Let us focus here alone on the factor cost ratio as defined in (iii). This variable formally represents the price mechanism which, however, does not work as Orthodoxy hallucinates. As a matter of fact, overall employment increases if the average wage rate W increases relative to average price P and productivity R.

The core of the employment problem is that the price mechanism does not work as orthodox economics says and this has nothing to do with wage or price stickiness but only with scientific incompetence.

Forder’s Phillips curve summary can be generalized for all of economics: “None of those things is true. Indeed, it is a stretch to say that any of them has an element of truth. They are part of a widely believed fiction and certainly the story taken as a whole has no historical merit.”

Egmont Kakarot-Handtke


References
Hicks, J. R. (1939). Value and Capital. Oxford: Clarendon Press, 2nd edition.
Kakarot-Handtke, E. (2012). Keynes’s Employment Function and the Gratuitous Phillips Curve Disaster. SSRN Working Paper Series, 2130421: 1–19. URL
Stigum, B. P. (1991). Toward a Formal Science of Economics: The Axiomatic Method in Economics and Econometrics. Cambridge, MA: MIT Press.

* See ‘The Hicks drive’ and ‘Mental messies and loose losers’ and ‘The Humpty Dumpty methodology