August 4, 2017

A la recherche de l'inflation perdue

Comment on David Andolfatto on ‘Where’s the inflation?’

Blog-Reference and Blog-Reference

David Andolfatto asks: “What accounts for the missing inflation? In a recent NYT article, Binyamin Appelbaum mentions four theories of inflation: (1) Monetarist, (2) Phillips Curve, (3) Expectations, and (4) Internationalist.”

Obviously, economists are lost in the woods. The ultimate reason is no other than their scientific incompetence. For concise proof let us focus here on the Phillips curve.

The fact that the Phillips curve now seems to be flat only tells one that it has been misspecified all along. Thanks to the scientific incompetence of economists this remained undetected since Samuelson/Solow messed things up. The methodological blunder consists of interpreting the Phillips curve as a behavioral relationship. What has to be done is to formulate the Phillips curve as an objective structural-systemic relationship.#1 This relationship consists alone of measurable variables and is therefore readily testable.

From the correct systemic relationship follows that employment L depends (i) on aggregate demand, and (ii), on the price mechanism, which is formally embodied in the macro-ratio rhoF=W/PR with W = (average) wage rate, P = (average) price, and R = (average) productivity. The first thing to notice is that wage rate and price both can ― as a matter of principle ― move independently. Their respective movements co-determine with any given composition of aggregate demand employment. There is no fixed behavioral feedback dependency between employment and wage rate/price either.

Let all other variables be fixed and the rate of change of productivity R for simplicity be zero, i.e. r=0, then there are THREE logical cases: (i) 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. (ii) The rate of change of the wage rate is greater than the rate of change of the price then employment INCREASES. (iii) The rate of change of the wage rate is less than the rate of change of the price then employment DECREASES.

So, it is DIFFERENCES in the rates of change of wage rate and price and NOT the absolute magnitude of change that affects employment. Every perfectly SYNCHRONOUS inflation/deflation/hyperinflation is employment-neutral, that is, employment sticks indefinitely where it actually is.

The correct systemic Phillips curve tells one (i) that there is no necessary behavioral relationship between employment and inflation, and (ii), prolonged synchronous inflation or hyperinflation does not happen by accident but must be engineered. The normal course is that price inflation is faster than wage inflation and this means increasing unemployment.

The answer to the question ‘Where’s the inflation?’ is roughly speaking: there is (worldwide) deflation because the increase of the average wage rate lags behind the increase of the average productivity.

Egmont Kakarot-Handtke

#1 For more details see Putting economic policy on scientific foundations.