Sunday, April 24, 2011

A Keen Easter

From Steve Keen's Debtwatch post of 11 April 2011:
Keen provides several graphs which I am omitting.
But then the so-called “stagflationary” breakdown occurred: unemployment and inflation both rose in 1974. Neoclassical economists blamed this on “Keynesian” economic policy, which they argued caused people’s expectations of inflation to rise—thus resulting in demands for higher wages—and OPEC’s oil price hike.

The latter argument is easily refuted by checking the data: inflation took off well before OPEC’s price hike.

The former has some credence as an explanation for the take-off in the inflation rate—workers were factoring in both the bargaining power of low unemployment and a lagged response to rising inflation into their wage demands.

The Neoclassical explanation for why this rise in inflation also coincided with rising unemployment was “Keynesian” policy had kept unemployment below its “Natural” rate, and it was merely returning to this level. This was plausible enough to swing the policy pendulum towards Neoclassical thinking back then, but it looks a lot less plausible with the benefit of hindsight.

Though inflation fell fairly rapidly, and unemployment ultimately fell after several cycles of rising unemployment, over the entire “Neoclassical” period both inflation and unemployment were higher than they were under the “Keynesian” period. So rather than inflation going down and unemployment going up, as neoclassical economists expected, both rose—with unemployment rising substantially. On empirical grounds alone, the neoclassical period was a failure, even before the GFC hit.

Table 1

Policy dominance Keynesian Neoclassical
Years 1955-1976 1976-Now
Average Inflation 4.5 5.4
Average Unemployment 2.1 7

There was a far better explanation of the 1970s experience lurking in data ignored by neoclassical economics: the level and rate of growth of private debt.

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