January 18, 2018

Economists never understood how the price mechanism works

Comment on David Glasner on ‘Milton Friedman and the Phillips Curve’

Blog-Reference and Blog-Reference on Jan 19

The economists’ idea of the price mechanism is encapsulated in the Totem of the Micro, i.e. supply-curve-demand-curve-equilibrium. Because each of the three elements is a NONENTITY and the generalization for the whole economy is a Fallacy of Composition, price theory will forever remain one of the most laughable constructs in the history of wannabe science. It is not really funny, though, because the paradigmatic case of the Phillips curve proves how the scientific incompetence of economists ruins the economy.

The basic idea of the working of the price mechanism goes a follows “In other words, you can’t make the economy as a whole better off just by printing money. Or can you? Actually, you can, and Friedman himself understood that you can, but he argued that the possibility of making the economy as a whole better off (in the sense of increasing total output and employment) depends crucially on whether inflation is expected or unexpected. Only if inflation is not expected does it serve to increase output and employment.” (Glasner)

Exactly the opposite is, in fact, the case, a one-off or permanent or accelerating macroeconomic price increase does NOT increase employment but unemployment. In other words, economists got the Phillips Curve catastrophically wrong.#1, #2

In order to see this one has to go back to the axiomatic foundations and replace microfoundations with true macrofoundations.#3 The elementary version of the correct (objective, systemic, behavior-free, macrofounded) Employment Law is shown on Wikimedia: #4

From this equation follows:
(i) An increase in the expenditure ratio ρE leads to higher employment L (the Greek letter ρ stands for ratio).
(ii) Increasing investment expenditures I exert a positive influence on employment.
(iii) An increase in the factor cost ratio ρF≡W/PR leads to higher employment.

The complete Employment Law contains in addition profit distribution, the public sector, and foreign trade.

Item (i) and (ii) cover the familiar arguments about aggregate demand. The factor cost ratio ρF as defined in (iii) embodies the macroeconomic price mechanism. The fact of the matter is that overall employment INCREASES if the average wage rate W INCREASES relative to average price P and productivity R. Or, the other way round, overall employment DECREASES if the average price P INCREASES relative to average wage rate W.#5 Roughly speaking, inflation is BAD for employment and this is the OPPOSITE of what microfounded economics teaches and what supply-demand-equilibrium economists still believe since Friedman’s proto-scientific garbage was applauded by the dull members of the American Economic Association.

Egmont Kakarot-Handtke

#1 NAIRU, wage-led growth, and Samuelson’s Dyscalculia
#2 Keynes’ Employment Function and the Gratuitous Phillips Curve Disaster
#3 The macrofoundations approach starts with SYSTEMIC axioms: (A0) The objectively given and most elementary configuration of the economy consists of the household and the business sector which in turn consists initially of one giant fully integrated firm. (A1) Yw=WL wage income Yw is equal to wage rate W times working hours. L, (A2) O=RL output O is equal to productivity R times working hours L, (A3) C=PX consumption expenditure C is equal to price P times quantity bought/sold X.
#4 Wikimedia AXEC62 Employment Law
#5 Attention: there are THREE types of inflation

Related 'Macro for retarded economists' and 'Microfoundations R.I.P.' and 'Economists, stupid or corrupt or both?' and 'The Three Fatal Mistakes of Yesterday Economics: Profit, I=S, Employment' and 'Essentials of Constructive Heterodoxy: The Market' and 'Rethinking macro'. For details of the big picture see cross-references Employmen/Phillips Curve and cross-references Paradigm Shift.