May 30, 2016

False theory makes wrong policy: economics as loose cannon

Comment on Lars Syll on ‘NAIRU — a harmful fairy tale’


The NAIRU aberration goes back to the false interpretation of the Phillips curve (2012). The correct curve is reproduced here.

From the structural Phillips curve, which is entirely FREE of rational expectation and natural rate nonsense, follows inter alia:
(i) An increase of the expenditure ratio rhoE leads to higher employment L (the letter rho stands for ratio).
(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.

The complete structural Phillips curve is a bit longer and contains, in addition, public deficit spending and import/export.

Item (i) and (ii) cover the familiar arguments about how aggregate demand affects employment. Item (iii) embodies the price mechanism. It works such that overall employment L INCREASES if the average wage rate W INCREASES relative to average price P and productivity R and vice versa. The structural Phillips curve contains the original curve as limiting case.

The structural Phillips curve contains nothing but measurable variables and is readily testable. The NAIRU model is provably false and leads to wrong policy advice.*

Egmont Kakarot-Handtke

Kakarot-Handtke, E. (2012). Keynes’s Employment Function and the Gratuitous Phillips Curve Disaster. SSRN Working Paper Series, 2130421: 1–19. URL

* See also ‘What Keynes really meant but could not really prove’.