The F story about the Great Inflation (knowledge transmission)
Simon Wren-Lewis takes a look back to the 60s and 70s…”The reason I write about this now is that I’m in the process of finishing a paper on the knowledge transmission mechanism and the 2010 switch to austerity, and I wanted to look back at previous macroeconomic crises.” Robert Waldmann is part of this post.
The F story about the Great Inflation
Here F could stand for folk. The story that is often told by economists to their students goes as follows. After Phillips discovered his curve, which relates inflation to unemployment, Samuelson and Solow in 1960 suggested this implied a trade-off that policymakers could use. They could permanently have a bit less unemployment at the cost of a bit more inflation. Policymakers took up that option, but then could not understand why inflation didn’t just go up a bit, but kept on going up and up. Along came Milton Friedman to the rescue, who in a 1968 presidential address argued that inflation also depended on inflation expectations, which meant the long run Phillips curve was vertical and there was no permanent inflation unemployment trade-off. Policymakers then saw the light, and the steady rise in inflation seen in the 1960s and 1970s came to an end.
This is a neat little story, particularly if you like the idea that all great macroeconomic disasters stem from errors in mainstream macroeconomics. However even a half awake student should spot one small difficulty with this tale. Why did it take over 10 years for Friedman’s wisdom to be adopted by policymakers, while Samuelson and Solow’s alleged mistake seems to have been adopted quickly? Even if you think that the inflation problem only really started in the 1970s that imparts a 10 year lag into the knowledge transmission mechanism, which is a little strange.
However none of that matters, because this folk story is simply untrue. There has been some discussion of this in blogs (by Robert Waldmann in particular – see Mark Thoma here), and the best source on this is another F: James Forder. There are papers (e.g. here), but the most comprehensive source is now hisbook, which presents an exhaustive study of this folk story. It is, he argues, untrue in every respect. Not only did Samuelson and Solow not argue that there was a permanent inflation unemployment trade-off that policymakers could exploit, policymakers never believed there was such a trade-off. So how did this folk story arise? Quite simply from another F: Friedman himself, in his Nobel Prize lecture in 1977.
The reason I write about this now is that I’m in the process of finishing a paper on the knowledge transmission mechanism and the 2010 switch to austerity, and I wanted to look back at previous macroeconomic crises.
Another F: Fascinating.
I had not heard that before. Thanks.
And it is not just economics.
Once you grant yourself free choice of lag effects and the principle that even if correlation doesn’t EQUAL causation it is pretty damn suggestive then you can combine those two and prove anything. Leading to the conclusion that “Conservatism (or libertarianism or communism) cannot be failed, it can only be failed (or never actually put into practice despite labels).
I put a lot of this down to the fact that people on the right and on the far left see most of everything as being equivalent to a forensic debate or a trial at law. To the victor goes the spoils and the proof is in the verdict and not the actual validity of the argument.
Hence the “Reality Based” trap. Sure you are CORRECT based on preponderance of the evidence. But I just polled the jury and they didn’t agree. Because I made the better argument.
BTW this is why back in antiquity people hated the Sophist philosophers. Their touchtstone wasn’t Truth but instead ‘Winning!’.
This is awesome because you can actually observe the moment where Simon Wren-Lewis demonstrates that economics is empty of meaningful content. Unfortunately you dot dot dot right over the important part. Watch what happens in the original:
If it wasn’t a belief in a long run inflation unemployment trade-off, what was it that allowed inflation to gradually rise during those two decades?
If Economics was a body of knowledge about the world, what would happen next?
Observation of the phenomenon that one is trying to understand. In this case, that would involve interviews with policy makers. But policy makers disappear entirely. Instead we have the observation that economists used the phrase “cost-push inflation”. But that actual fact has no causal role in his argument. His actual claim is that two ideas in the heads of economists caused inflation.
Go ahead. Re-read what he wrote. Two ideas in the heads of economists caused inflation.
And this is a guy Paul Krugman routinely praises. Economics is the null set.
This is what happens when you create a life science where the barriers to entry require scientists to prove they are good at physics.
Thornton I am not sure what you are saying here, but I do like the cut of your jib (as we oldsters used to say in approval).
What may be the same point is that for the last few decades it has been an absolute requirement in most PhD program in Philosophy, at least in England and the U.S. to pass a course in Formal Logic.
Similarly it has been an absolute requirement that anyone entering a PhD program in Economics has to master Calculus and often higher maths.
What has never been clear is whether Formal Logic is an actual key to getting to Philosophical Truth or that facility in Mathematical Models actually gives more insight into Economic Truths than the equivalent amount of study in the history of philosophy or historical economics.
But man all those exotic symbols used in Logic and all those Greek letters and crossing lines on Econ Department whiteboards must mean SOMETHING that us mere mortals just are not trained to grasp.
Barriers to entry indeed.
I think the single most important insight of an undergraduate philosophy is what happens after 2 or 3 classes dedicated to moral philosophy. One realizes that there is no set of internally consistent premises that successfully maps to our strongly held and universal moral intuitions. Morality exists. There is moral truth. There are moral facts. There is no true theory of morals.
That is to say, the single most important lesson in philosophy is that the set of facts/truth consistent with a more general theory is a subset of the truth of the human condition. Philosophy PhDs may use a bunch of formal logic but most have run into the total failure of moral theory, and all have seen the intractibility of the “is/ought” problem.
So that’s my defense of my Phil profs (no PhD to my name).
And with economics, it’s more than fancy/off-putting symbols. It’s about talents that don’t usually overlap. For whatever reason, people who are good at physics are not the same people who seek to learn about how humans relate to each other by studying the beast in the field. But that is what economic seeks to understand: the pecuniary subset of human social behavior.
The exception that proves the rule: when economists do study actual human behavior (although not that of bankers or brokers but just random schmos) they come to the conclusion that their subjects are “misbehaving”. Imagine Jane Goodall saying, “I studied chimp behavior in the wild for decades and came to a clear conclusion: the chimps are doing it wrong. You’d think a chimp would know how to be a chimp, but no!”
Bravo Thornton Hall, economics is theory devoid of historical facts.
“Why did it take over 10 years for Friedman’s wisdom to be adopted by policymakers, while Samuelson and Solow’s alleged mistake seems to have been adopted quickly?”
Historically I think it was during Greenspan’s term in White House and Nixon was look for a way for friends to do business in Africa; Greenspan introduced Friedman’s theory on free trade to Nixon.
Ignoring that apparently the story isn’t true, I would agree with Beene. The primary factory in “knowledge transmission” to politicians is most likely whether they agree with the policy that can be argued from the theory.
Also, knowing about advanced maths and modeling may not make you a better economist, but it does help you understand one of the major contributors to the foundations and papers in economics.
Similarly, you don’t need to know calculus to understand accounting and most BS programs in accounting won’t require you to take it, but if you want an MS, you’re going to need it because deriving some of the underlying assumptions requires that knowledge. Being able to use something and being able to understand how the useful thing came to be are two different things, one is a practical consideration and the other is required to master the field.
A couple of obvious questions.
1. What is the value of understanding “…one of the major contributors to the foundations and papers in economics.”? (Especially if there is a trade-off between understanding that or understanding why human beings buy or sell things?)
2. There’s theoretical accounting? Is it the case that one can “do accounting” and say meaningful accounting facts without observing an actual firm? With hidden assumptions that preclude the existence of an actual firm and an actual balance sheet with actual assets and actual liabilities?
If so, then perhaps accounting could be a useful metaphor for economics. But most accountants I know would lose their jobs if they, on principle, refused to empirically interact with the firm which employs them, accounting for how much money they “should have” ceritus paribus and not how much money they do have.
I would imagine that the value comes if you’re working in an academic setting primarily. Normally you would want to be informed about what other researchers are publishing currently, and to understand the various views on a topic, you would want to read the existing publications. Understanding those publications in many cases would require an understanding of the mathematical models included.
There is definitely theoretical accounting. Most of the applications of calculus in deriving accounting equations/models/formulas are related to estimating the value of market prices for assets. When Fischer Black and Myron Scholes developed their options pricing model, that was in the early 70’s and it was largely theoretical (in that it was not required to be used in any “normal” accounting job), and the model is all differential equations and surfaces and other calculus crap. In practice, organizations plug their numbers into a program and it spits out a number that they put on their financial statements.
Working as an accountant is different than working in an organization that sets accounting standards and principles or working in accounting academia.
If you want to argue about the distinction between day to day accounting and financial reporting, this probably isn’t the right venue for that.