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.
Why would I care what Keynes thought? If the theory is solid, it doesn’t matter what he said or thought. There’s a rationalist saying “evidence screens off authority”. Why waste time defending a long dead man?
jsalvatier,
1. The theory isn’t solid.
2. There are a bunch of people who are tarring everybody who can be described as having Keynesian views based on this. This is just another way to point out that most of us don’t believe in the stuff that certain folks insist we do believe in, and that its been known to be wrong for a very long time (i.e., since Keynes).
Again I strongly agree with Mike. The fact that the Phillips curve is not a social law is considered the revolutionary change in macroeconomics in the 70s. A huge amount of implausible (and mathematically fancy) theorising is justified by the claim that looking at data without theory led people to count on the Phillips curve. The claim that Keynes failed to understand — well what I quote Keynes asserting — is very central to the debate about the proper method to use to understand the macroeconomy.
The argument “Keynes was confused and wrong and it should have been obvious but he was revered for decades so you have to do it my way” is not valid in any case. However, it had a huge impact. So the fact that the premise of the argument is false is of some interest.
In other words, I’m say that I agree that the debate is pointless but they started it
(here I am attempting self parody, which I don’t reliably make clear without tone of voice and facial expressions and such or an explanation in parentheses).
I guess most people don’t care what Keynes thought, because most people don’t comment on these posts. I put the first in the series on my personal blog (40 visits a day). Then it received hundreds of visits, so I decided someone was interested (that someone is named Mark Thoma).
There are a few other reasons to cut and paste what Keynes wrote. For one thing the contrast between Keynes and Keynesian economics as presented in textbooks is so dramatic that it is actually funny. For another, economists are supposed to know what Keynes wrote (this is unusual mostly economics tries to be like a natural science where old writing isn’t read). But many clearly forgot it long ago. It is genuinely funny when Robert Barro asserts that Keynes wrote Robert Barro’s PhD dissertation which Robert Barro once claimed was a significant and *original* piece of research (which it was, even if he hates it now).
Finally there may be an actual practical reason to read Keynes. He presented many ideas which he didn’t work out. They are scattered in the book. They are topics for possible research. Ideas which are so old that they are new have played a role in fairly recent research. The academic discussion gets closed in on itself and brining in other thoughs, including forgotten thoughts from decades old academic discussion is often useful
I find this very interesting because so many people attack Keynes who never read him (and I admit to only reading is popular essays, not the hard stuff because I am not a professional economist. It is somewhat like Adam Smith, who is constantly being misquoted to serve some current ideology that the real Adam Smit of “Wealth of Nations” and “Moral Sentiments” might not approve.
“Why would I care what Keynes thought?”
A similar question could be asked regarding Einstein, or Marx, or Confusius or Nightengale, with equal justification in each case. You won’t catch me asking that question with regard to any of these people, but others are free to ask it.
Robert,
I just ducked over to the Wikipedia article on the Phillips Curve. You might want to go there and offer an edit. The article explicitly says that Phillips’ research opened the way to Keynesian efforts to lower unemployment, with the clear implication that Phillips-curve policies are Keynesian policies.
Oh, and, Irving Fisher wanted us to know that Irving Fisher discovered the Phillips curve, publishing on it in 1926. That opens the possibility that Keynes actually had specific research in mind when he warned against relying on a relationship between unemployment and inflation. If he did, then what you (Robert) have pointed out is more than Keynes innocently disagreeing with Phillips-based thinking before the fact. It is Keynes warning against the very idea that was drawn from Phillips’ work and made into policy – no room at all for Phillips curve nostrums being “Keynesian” policy.
http://www.jstor.org/pss/1830534
j.salvatier
why would i care what a brain dead blog commenter thinks?
oh, maybe because it’s interesting. i certainly agree that “evidence screens off authority” if that means that for purposes of “proof,” some appeal to logic and evidence counts more than “ipse dixit.” but once in a while begining with..and crediting.. the arguments of a great man is a good place to start to understand the question.
and a small note for those who “rightly” dislike algebra.
I used to like algebra and enjoyed putting arguments into mathematical form, but i think that in a field like economics it is probably more important to be able to put them into a verbal form that keeps the reader aware of how very subject the whole thing is to unexamined variables. the algebraic form can delude both reader and writer into thinking he is on to something “solid.”
Then there’s the point that Krugman makes – the entire Chicago school of economic thought seeems not so much to disagree with Keynes as to be almost totally unaware of his existence. Then they make pronouncements that Keynes disproved long before they were born as if they were startlingly new revelations.
Sometimes knowing the history of thought can keep one from repeating old errors.
Cheers!
Jzb
You and jsalvatier are both right for different reasons because your perspectives differ. To an economist trying to advance the field through scientific examination, it should be the substance that matters, not so much the name; if the Phillips curve is wrong or misinterpreted or misapplied, it should not matter much who developed it, and this posting about the views of Keynes is not so relevant. However, it is also EXTREMELY important to defend Keynes from unwarranted and inaccurate attacks, and to perform related “fact-checking,” for many other reasons–this posting is a valuable contribution to those efforts. Furthermore, such efforts arguably are today more important to the advancement of the field. If you fail to defend Keynes, you fail to defend Keynesian economics as an alternative approach, and you condemn the field to follow a narrow path that has been far less productive and far more damaging than it’s adherents will ever admit.
The Integral of dy/dx ~ 1/X is y ~ ln(x) + C ? The rate of change of the wage rate is proportional to the rate of employment demand.
Why would that be controversial ? It makes a lot of sense to me. The faster the growth in employment, the faster the increase in wage rates,and, conversely, the faster the rate of decline as under employment takes hold during a recession. At some point in the unemployment cycle, like now, wages level off, even as unemployment increases. Perhaps a marginal substitution effect.
Maybe the economics community should pay more attention to calculus in determining is a market a market bubble is under way.
Thanks for the post on Keynes. Since Keynes provides the fundamental cornerstone behind a huge body of policy, the evolution of economic thought (theoretically) and current economic models, reflections on the primitive basis, ie what he actually said, is good. The policies of the FDR revolution has both feet in Keynesian theory and practice. Conversely, the Republican and Libertarian prescriptions at the root of our current situation (Ronny Rayguns through GWB) have Uncle Milty as their funny uncle, and Keynes as their father (bailing their asses out).
So many wah wahs !
The Integral of dy/dx ~ 1/X is y ~ ln(x) + C ? The rate of change of the wage rate is proportional to the rate of employment demand.
should have read:
The Integral of dy/dx ~ 1/X is y ~ ln(x) + C ? The rate of change of the wage rate is proportional to the rate of change in employment demand.
We can go further. We can take the so called Phillips Curve ( a seemingly obvious invention for anyone with a slide rule) and relate the rate of change of the wage rate to the rate of increase in employment which would result in a curve that most people would immediately understand. In a fast growth economy, the marginal rate of pay increases faster than the rate of employment. The Billy Clinton tech bubble.
Along with that faster growth in the rate of pay, with sensible increases in the marginal tax rate, buda bing, balanced budgets.
Then along comes the village idiot. I think an informed discussion of how the shift the risk philosophy of GWB and his predecessors put the US in the sad position it currently finds itself.
Ok, so it’s plausible there is a Phillips Curve for the wage part of a wage-price inflationary spiral (I never felt I was winning that one in the late ’70s. That didn’t happen until my IT time in the 90s) , or the wage part of a wage-price disinflationary spiral.
A lower limit may be sticky wages, an upper limit may be outsourcing, offshoring etc….
But I don’t still don’t believe inflation creates jobs.
This is the part where someone needs to chime in and advise if Keynes, et all, was talking “nominal” or “real” wages. I always hate that part.
IMO, Inflation is the natural response to the rapid rise in wages and the coincident propensity rate to consume.
Stagflation occurs at the end of the party when, the Fed has accomodated the boom with too much money.
I think we have a stagflation in place now. Even though we have exported a huge number of jobs, (12 MM), the mercantilists are experincing inflation from their currency devaluations at the same time that state governments are experiencing stagflation from the drop in revenues. I do not hear anyone claiming that the trade imbalance is resulting in lower consumer prices or higher quality. The twin bonanzas that the Ivy league has sold America these last two decades.
Yup. I think it’s stagnation for some indeterminate period of time, then we import inflation, both from mfg. goods and oil, then we mix the two together and have stagflation, of the type that has little or negative real wage growth.
Of course the way health care is going, future deficit reduction from inevitable tax hikes, and global warming costs, we probably won’t have any money to spend on anything else anyway.
Cedric,
The Fed is required by law to promote the maximum sustainable level of employment. In a political world, it is sometimes advisable to say you are doing what the law requires, when what the law requires is also what your political bosses want you to do.
Beyond that, the Phillips curve related inflation to employment. As noted, that was an empirical artifact discovered in UK data from 1861 to 1957. The behavior explanation imposed on the artifact was that workers were being tricked into accepting lower real wages by having a bit more inflation than they expected, and that lower wages led to higher employment.
It is entirely possible to see monetary stimulus lifting employment by means that indulge less in “carney skinning the rubes” thinking. If there is unused capital in the economy, and there is a large pool of unemployed workers who could use that capital, then you can get a direct increase in real activity, without having to lower the cost of labor. A direct lift to demand can lead to an increase in output, which leads to an increase in demand for the inputs to output, including labor. It isn’t necessarily a Phillips curve trick that’s being attempted.
Problem is, the targets at which lower rates are aimed are housing and plant and equipment, with the emphasis on housing and plant. We have more of both than we need. That suggests monetary policy won’t work very well, even if we aren’t playing a Phillips curve trick.
– Edit – Moderate
You have good company Coberly. This is exactly the stated view of Marshall (who was justifying using math at all to skeptics) and Keynes (who clearly meant it and translated everything he could back into English and had little interest in the untraslatable gobbledgook in chapter 20).
Unfortunately, most leading economists who agreed with you are dead. The record of economic theory in our lifetimes very much supports your view.
Krugman is too polite. Indeed many members of the Chicago school clearly have no idea what Keynes wrote. A leading (and very powerful) member of the school Judge Richard Posner, recently read “The General Theory …” and was amazed, and said so.
However, not all can plead ignorance. In particular, Robert Lucas must be familiar with Keynes. Keynes couldn’t be dodged when Lucas was young. I don’t believe he has forgotten. I think he is being other than completely frank.