March 5, 2017

NAIRU and economists’ lethal swampiness

Comment on David Glasner on ‘Richard Lipsey and the Phillips Curve Redux’

Blog-Reference and Blog-Reference

David Glasner contributes to the NAIRU discussion#1 by reproducing essential content of his 2013 paper. Back then he propagated Lipsey’s concept of multiple equilibria or band of unemployment (NAIBU) which is consistent with a stable rate of inflation. The NAIBU concept is a fine example of the tendency of economists to soften, relativize, qualify, and semantically dilute every concept until it is senseless and useless.

It is the very characteristic of economics that there are no well-defined concepts and this begins with the pivotal economic concepts profit and income. The habit of swampification keeps the discourse safely in the no man’s land where “nothing is clear and everything is possible” (Keynes) and where anything goes.

Swampiness is what Popper called an immunizing stratagem. The beauty of vagueness and ambiguity is that it cannot be falsified: “Another thing I must point out is that you cannot prove a vague theory wrong.” (Feynman)#2

David Glasner applies the concept of evolution in order to swampify the NAIRU: “The current behavior of economies … is consistent with evolutionary theory in which the economy is constantly evolving in the face of path-dependent, endogenously generated, technological change, and has a wide range of unemployment and GDP over which the inflation rate is stable.”

In other words, presumably there is a relationship between unemployment and inflation but nobody knows what it is. While science is known to strive for uniqueness, economics is known to strive for ambiguity and obfuscation. This swampiness is rationalized as realism. After all, reality is messy, isn’t it?

To recall, the Phillips curve started as a simple and remarkably stable EMPIRICAL relationship between wage rate changes and the rate of unemployment. The original Phillips curve subsequently has been reinterpreted and thereby messed up by Samuelson and Solow who introduced the economic policy trade-off between inflation and unemployment which was finally thrown out again with the NAIRU.

A conceptional error/mistake/blunder slipped in with the bastardization of the original Phillips curve that was never rectified but in effect buried under a huge heap of inconclusive economic shop talk. This means that until this very day economics has no valid theory of the labor market.

So, the microfounded NAIRU-Phillips curve has first of all to be rectified.#3 The macrofounded SYSTEM-Phillips curve is shown on Wikimedia.

From this correct employment equation follows in the MOST ELEMENTARY case that an increase of the macro-ratio rhoF=W/PR leads to higher total employment L. The ratio rhoF embodies the price mechanism. Let the rate of change of productivity R for simplicity be zero, i.e. r=0, then there are three logical cases, that is, THREE types of inflation.

(i) If the rate of change of the wage rate W is equal to the rate of change of the price P, i.e. w=p, then employment does NOT change NO MATTER how big or small the rates of change are. That is, NO amount of inflation or deflation has any effect on employment. Inflation is neutral, there is no trade-off between unemployment and inflation.
(ii) If the rate of change of the wage rate is greater than the rate of change of the price then employment INCREASES. There is a POSITIVE effect of inflation on employment.
(iii) If the rate of change of the wage rate is smaller than the rate of change of the price then employment DECREASES. There is a NEGATIVE effect of inflation on employment.

So, it is the DIFFERENCE in the rates of change of wage rate and price and not the absolute magnitude of change that is decisive. Every PERFECTLY SYNCHRONOUS inflation/deflation is employment-neutral, that is, employment remains indefinitely where it actually is. The neutral inflation can start at ANY point between full and zero employment. The crucial fact to notice is that there is no such thing as “inflation”, there are THREE types of inflation.

The systemic employment equation defines the causal relationship of “inflation” on employment. However, there is the inverse causality of employment on “inflation”.

Common sense suggests that positive inflation (ii) is more probable the closer actual employment is at full employment and negative inflation (iii) is more probable the farther away actual employment is from full employment. In other words: the market economy is inherently unstable. The feed-back loop between employment and “inflation” is the very antithesis to the idea of equilibrium. To recall, the NAIRU is DEFINED as an equilibrium. Standard economics has built equilibrium right into the premises, i.e. into the axiomatic foundations. All of economics starts with the idea that the market economy is an equilibrium system. It turns out that this premise is false, just the opposite is the case.

Standard labor market theory as it is incorporated in the NAIRU-Phillips curve is not vaguely true, or evolutionary true as David Glasner maintains, but provable false.

Egmont Kakarot-Handtke

#1 See ‘NAIRU: an exhaustive dancing-angels-on-a-pinpoint blather’ and ‘NAIRU and the scientific incompetence of Orthodoxy and Heterodoxy’ and 'NAIRU does not exist because equilibrium does not exist'
#2 “By having a vague theory it is possible to get either result. ... It is usually said when this is pointed out, ‘When you are dealing with psychological matters things can’t be defined so precisely’. Yes, but then you cannot claim to know anything about it.”
#3 See ‘Keynes’ Employment Function and the Gratuitous Phillips Curve Disaster