Saturday, April 12, 2014

"Wreckage"


From The History of the Phillips Curve: Consensus and Bifurcation by Robert J. Gordon (PDF, 41 pages, 2008):
Introduction

The history of the Phillips curve (PC) has evolved in two phases, before and after 1975, with a widespread consensus about the pre-1975 evolution, which is well understood...

The pre-1975 history is straightforward and is covered in Section I. The initial discovery of the negative inflation–unemployment relation by Phillips, popularized by Samuelson and Solow, was followed by a brief period in which policy-makers assumed that they could exploit the trade-off to reduce unemployment at a small cost of additional inflation. Then the natural rate revolution of Friedman, Phelps and Lucas overturned the policy-exploitable trade-off in favour of long-run monetary neutrality. Those who had implemented the econometric version of the trade-off PC in the 1960s reeled in disbelief when Sargent demonstrated the logical failure of their test of neutrality, and finally were condemned to the ‘wreckage’ of Keynesian economics by Lucas and Sargent following the twist of the inflation–unemployment correlation from negative in the 1960s to positive in the 1970s.


From After Keynesian Macroeconomics by Robert E. Lucas and Thomas J. Sargent (PDF, 34 pages, 1978):
1. Introduction

We dwell on these halcyon days of Keynesian economics because, without conscious effort, they are difficult to recall today...

That these predictions were wildly incorrect, and that the doctrine on which they were based is fundamentally flawed, are now simple matters of fact, involving no novelties in economic theory. The task which faces contemporary students of the business cycle is that of sorting through the wreckage, determining which features of that remarkable intellectual event called the Keynesian Revolution can be salvaged and put to good use, and which others must be discarded.



For the record...

The "negative" correlation of the Phillips Curve is the tradeoff: a little more inflation and a little less unemployment, or the reverse. The "positive" correlation is when both inflation and unemployment increase, or both decrease.

The negative correlation displays the tradeoff for given economic conditions. The positive correlation shows what happens when economic conditions improve or get worse. When people deny the existence of the tradeoff, it is because they are considering the long term, during which the condition of the economy varies. Even so, the tradeoff still applies to the short term.

But the proper fix for our economy is not to fiddle with the short-term tradeoff. The proper fix is to figure out how to improve conditions over the long term.

3 comments:

Gene Hayward said...

Hey, Art,

Not sure this advances the discussion of your post but thought I would give you a little insight as to what the College Board AP Macroeconomics curriculum requires teachers to teach for test preparation regarding the Phillips Curve (both the Short Run P.C. and the Long Run PC).

It is a model that is prominent on the test and appears over and over. It is one of 6 graphs("models") that students must master if they want to do well.

Here is the short version of the Short Run Phillips Curve we teach: The negative relationship between inflation and unemployment occurs as a result of shifts in Aggregate Demand (AD) along a fixed Short Run Aggregate Supply (SRAS) curve. Boom! That's it. Policy makers (Fiscal and/or Monetary) implement AD policies to address the particular "evil" of the day (inflation OR Unemployment). Case closed.

As far as "discrediting" of the SRPC in the 70's we ONLY speak of that "off the record" to students. What we teach for curriculum is that the SRPC SHIFTS to the RIGHT as a result of a "negative Short Run Aggregate Supply shock"--SRAS shifts to the LEFT along the fixed AD curve.

The implication is the SRPC curve remains intact as a concept, but just as at a higher level of inflation at every given unemployment rate.

While the curriculum is clear on how to address AD problem ("activist" fiscal and/or monetary policies" along with the in-place automatic stabilizers) it is less clear on how to address the negative supply shock.

It kinda leaves us hanging to assume supply-side policies OR the "self-correcting mechanism" of the Classical Model.

If you want to see the outline of the curriculum it is here at this link. For High School students (even advanced ones) I think it is pretty heavy stuff.

Well, that is my two cents worth. Keep the change!! :)

http://media.collegeboard.com/digitalServices/pdf/ap/ap-economics-course-description.pdf

Gene Hayward said...

You might want to answer some of the sample Multiple Choice questions available at the link for Micro and Macro.

I will give you a grade for it! :)

The Arthurian said...

This is great, Gene. Thank you. I don't often think in terms of the AS & AD graphs ("models") so if I have anything wrong, let me know.

The "short version" you present seems to fit well with what's in my head. SRAS is "fixed" -- Okay, that makes sense. So if there are changes in inflation and unemployment it must be due to short run changes in AD... In the back of my mind are reasons for those AD changes (and they may not be "short run" so much as the gradual exposition of a continuing trend)... Those changes seem to be ignored by the "short version" though I'm sure they are considered in longer versions of the story. (Yes, and you get to it later, come to think of it.)

The short version seems to rely heavily on policy as a cure. This surprises me, as my internet experience suggests that mainstream economists reject fiscal policy altogether in favor of monetary, and even have doubts about monetary policy. Also, implementing "AD policies" seems a particularly Keynesian approach. This surprises me as well. I thought Keynesianism was dead until Obama resurrected it. (Again, much of what I know comes from the Internet.)

The undermining of the Phillips Curve by Friedman (and Phelps) seems to be the foundation that Lucas and others built on. So I'm surprised (again) that it is not emphasized. Maybe you're trying to leave the politics out of it...

Where we differ most, the short version and me, is that they reduce the problem to a "negative Short Run Aggregate Supply shock" while I see a gradually growing problem arising from the one consistent trend they all ignore -- the growth of debt. (And frankly, I think the "shock" story is lame compared to the debt story.)

Oh... I looked at that collegeboard link. I'll have to study before I can answer any of those questions!!

Thanks again Gene.