What Keynes Wrote about The Phillips Curve

Robert Waldmann

Mike Kimel just remarked that Keynes was in no way responsible for the incorrect impression that the Phillips curve graphs the set of unemployment and inflation rates available to policy makers. In a comment, I said he was totally correct. In fact, I’d go further and argued that Keynes warned against that mistake as clearly as he could given the disadvantage that he was writing decades before Phillips.

Also Mark Thoma has twice linked to my pathbreaking effor to study the history of eonomic thought by cutting and pasting from “The General Theory ….”

Said cutting and pasting after the jump.

“Chapter 21. The Theory of Prices “

Contains the warning against the temptation to use a Phillips curve to come up with a theory of aggregate supply to go along with the theory of aggregate demand presented in chapters 1-18.

That the wage-unit may tend to rise before full employment has been reached, requires little comment or explanation. Since each group of workers will gain, cet. par. , by a rise in its own wages, there is naturally for all groups a pressure in this direction, which entrepreneurs will be more ready to meet when they are doing better business. For this reason a proportion of any increase in effective demand is likely to be absorbed in satisfying the upward tendency of the wage-unit.

Thus, … , we have a succession of … points at which an increasing effective demand tends to raise money-wages though not fully in proportion to the rise in the price of wage-goods; and similarly in the case of a decreasing effective demand. In actual experience the wage-unit does not change continuously in terms of money in response to every small change in effective demand; but discontinuously. These points of discontinuity are determined by the psychology of the workers and by the policies of employers and trade unions. … These points, where a further increase in effective demand in terms of money is liable to cause a discontinuous rise in the wage-unit … have … a good deal of historical importance. But they do not readily lend themselves to theoretical generalisations.

That is, the response of wages to aggregate demand in the real world is not smooth, simple or amenable to mathematical formalization. In other words, don’t put a Phillips curve into your models.

Just to confirm Mike’s recollection, I will deal with a much more boring passage which uses strange notation invented by Keynes. Other readers might want to quit hire.

As Mike Kimel recalled, Keynes also noted that the Phillips curve becomes vertical during a hyperinflation. Unfortunately he makes this point

Unfortunately it is expressed in terms of the obscure notation introduced in the first section of “Chapter 20. The Employment Function” whose one redeeming feature is footnote 1. “Those who (rightly) dislike algebra will lose little by omitting the first section of this chapter.”

The second half of chapter 20 isn’t all that much better, although it does include a presentation of the Lucas supply function, which is really the Keynes/Muth/Lucas supply function, for the case of clearning labor markets

(1) For a time at least, rising prices may delude entrepreneurs into increasing employment beyond the level which maximises their individual profits measured in terms of the product. For they are so accustomed to regard rising sale-proceeds in terms of money as a signal for expanding production, that they may continue to do so when this policy has in fact ceased to be to their best advantage; i.e. they may underestimate their marginal user cost in the new price environment.

Here is some boring notation from chapters 20 and 21.

e is the elasticity of prices with respect to the money supply.

e_d is the elasticity of money times velocity with respect to money.

e_w = (DdW )/(WdD) = the elasticity of nominal wages with respect to aggregate demand which equals MV.

we call money wages “nominal wages.” In other words e_w (which isn’t necessarily constant) is the elasticity of the Phillips curve expressed in terms of employment not unemployment.

“the case of a ‘flight from the currency’ in which e_d and e_w become large, e is, as a rule, less than unity.”

We call ‘flight from the currency’ hyper-inflation. Keynes is noting that money becomes neutral during hyperinflations. This, as noted by Thomas Sargent in “The End of Four Big Inflations” which was published some time after “The General Theory …” proves that the Phillips curve is not an economic law. The obscure quote confirms Mike Kimel’s vague recollection.

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