June 22, 2017

Rethinking the Phillips curve (I)

Comment on Nick Bunker on ‘Is the Fed being misguided by the Phillips curve?’


“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)

Fact is that economists do NOT have the true theory. This holds, in particular, for profit and employment theory which are provably false. The Phillips curve, for example, is misspecified since Samuelson.#1 So, yes, the Fed is constantly being misguided by provable false economic theory.

The correct employment equation is reproduced on Wikimedia.#2 From this objective-structural-systemic Phillips curve follows inter alia:
(i) An increase of the expenditure ratio rhoE leads to higher employment L (the Greek letter rho stands for ratio).
(ii) Increasing investment expenditures I exert a positive influence on employment.
(iii) An increase of the factor cost ratio rhoF=W/PR leads to higher employment.

The complete structural-systemic Phillips curve is a bit longer and contains, in addition, the public sector and the foreign trade sector.

Item (i) and (ii) cover the familiar arguments about how effective 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.

There is NOT much use in speculating if and when the wage rate rises if unemployment falls. There is NO law-like relationship between these variables. By consequence, wage rate and price have to be taken as parameters. The structural-systemic employment equation tells us how to exactly set the parameters in order to achieve the employment objective.

In the present situation, a theoretically enlightened and politically empowered FED (or some other competent institution) would set the parameters as follows: price increase zero and wage increase greater than productivity increase. This increases employment for a while. Afterwards: price increase zero and wage increase equal to productivity increase. This stabilizes the economy at full employment. Trying to steer price, wage rate and employment via the interest rate is a futile exercise that has NO sound theoretical foundation. To recall: economics is a failed science since 200+ years.

Egmont Kakarot-Handtke

#1 For details see ‘NAIRU, wage-led growth, and Samuelson’s Dyscalculia’ and ‘Keynes’ Employment Function and the Gratuitous Phillips Curve Disaster
#2 Wikimedia

Related 'Attention: there are THREE types of inflation' and 'Naive arithmetic' and 'NAIRU: an exhaustive dancing-angels-on-a-pinpoint blather' and 'Reading the correct Phillips curve correctly' and 'Nine views are nine too much' and 'The end of storytelling' and 'NAIRU and economists’ lethal swampiness' and 'NAIRU ― letting one more nonentity go'