WEBVTT NOTE Modern Myths of Keynesian Economics 1 00:00:00.000 --> 00:00:04.600 This morning I'd like to speak about two Keynesian myths. 2 00:00:04.600 --> 00:00:07.600 A myth, by the way, is something that does not exist. 3 00:00:07.600 --> 00:00:12.400 One is the Phillips Curve and the second is the multiplier. 4 00:00:12.400 --> 00:00:17.100 Phillips Curve, of course, is the alleged trade-off between inflation and unemployment 5 00:00:17.100 --> 00:00:22.300 and the corollary proposition that the government must tailor 6 00:00:22.300 --> 00:00:26.500 physical and monetary policy to this trade-off. 7 00:00:26.500 --> 00:00:30.260 It's entirely based upon empirical evidence. 8 00:00:30.260 --> 00:00:38.620 A graduate school professor of mine used to enjoy calling the Phillips Curve fact in search of a theory. 9 00:00:38.620 --> 00:00:42.660 I prefer Professor Rothbard's characterization. 10 00:00:42.660 --> 00:00:49.940 In the free market reader recently, he calls it perhaps the greatest, single most absurd error in modern economics. 11 00:00:49.940 --> 00:00:56.180 There are three reasons, categories of fallacies within the Phillips Curve that I'd like to talk about. 12 00:00:56.180 --> 00:01:08.180 One, very briefly, is epistemology, and the second is just as a theory, and lastly, as an empirical observation. 13 00:01:08.180 --> 00:01:18.180 Epistemologically, of course, facts cannot give us economic knowledge. Facts do not search theory quite the opposite. 14 00:01:18.180 --> 00:01:24.180 Mises has told us that theory is necessary to give meaning to facts. 15 00:01:24.180 --> 00:01:26.980 This is true for two reasons. 16 00:01:26.980 --> 00:01:32.580 One is the fundamental axiom of economics that human action exists. 17 00:01:32.580 --> 00:01:38.480 It is from that foundation, which by the way is irrefutable because any attempt to refute it is in fact action. 18 00:01:38.480 --> 00:01:47.780 It is from that beginning point that a process of deduction, the praxeological procedure, can give us economic knowledge. 19 00:01:47.780 --> 00:01:52.280 We can deduce true implication from the true premise. 20 00:01:54.280 --> 00:02:00.280 These conclusions that we derive furthermore are universally true. 21 00:02:00.280 --> 00:02:04.280 They cannot be refuted by any kind of evidence. 22 00:02:04.280 --> 00:02:10.280 In an empirical fashion, it would be similar to trying to attempt to refute the proposition that 23 00:02:10.280 --> 00:02:15.280 a ball cannot be both read and non-read all over simultaneously 24 00:02:15.280 --> 00:02:25.680 by testing that out in different locations, seeing if that were true in Chicago, whether it were true in 1950 as well as 1989. 25 00:02:25.680 --> 00:02:33.680 The second reason in epistemological sense that facts cannot give us economic theory 26 00:02:33.680 --> 00:02:41.280 is that the facts that are created by human action are what Mises called complex. 27 00:02:41.280 --> 00:02:44.280 They are not statistical facts. 28 00:02:44.280 --> 00:02:54.280 The data that forms inflation figures and unemployment numbers is formed in a complex non-statistical fashion, 29 00:02:54.280 --> 00:03:03.280 and I'll talk about this in more detail later, but it's unsuitable information for empirical work. 30 00:03:03.280 --> 00:03:13.280 In fact, even the positivists recognize the truth in this epistemological procedure of praxeology. 31 00:03:13.280 --> 00:03:23.280 They teach in their classes daily laws of economics and economic conclusions that are falsified. 32 00:03:23.280 --> 00:03:27.280 The law of demand, the law of supply, these things are mental constructs. 33 00:03:27.280 --> 00:03:30.280 They all understand that and they all teach those things 34 00:03:30.280 --> 00:03:39.280 And they all say that those are economic principles, but they are not falsifiable, they are not empirically verified. 35 00:03:41.280 --> 00:03:53.280 To turn to the theory of the Phillips Curve, all authors who have attempted to provide theory to explain the fact of the Phillips Curve have presented it as a theory of the labor market. 36 00:03:53.280 --> 00:04:00.780 I don't intend to repeat Professor Hoppe's praxeological explanation of how the labor 37 00:04:00.780 --> 00:04:10.400 market operates, but I would like to state just two things that must necessarily be incorporated 38 00:04:10.400 --> 00:04:15.080 into any theory of either the labor market or any market for that matter. 39 00:04:15.080 --> 00:04:18.720 And these are principal to the rest of the discussion about theory. 40 00:04:18.720 --> 00:04:27.200 One is that theoretically all propositions must be linked in some fashion to the existence 41 00:04:27.200 --> 00:04:29.400 of human action. 42 00:04:29.400 --> 00:04:35.200 That I think is a foundation of the criticism, the Austrian criticism of all non-Austrian 43 00:04:35.200 --> 00:04:43.000 schools of thought that if you cannot demonstrate how these principles are connected or consistent 44 00:04:43.000 --> 00:04:50.000 The second point, theoretically, is that when any proposition is made about market phenomena, it needs to be kept in mind that the market is just a shorthand term economists use for voluntary exchange, and voluntary exchange, on the other hand, is just a form of financial exchange. 45 00:05:13.000 --> 00:05:27.000 The form of action that people engage in in order to accomplish their end, to say that in a more traditional language, market phenomena is always the phenomena of cooperation and coordination. 46 00:05:27.000 --> 00:05:38.000 There is a prerequisite that assumption that when you go into the market you are attempting to engage in cooperation and coordination with other people. 47 00:05:38.000 --> 00:05:46.000 Hence, all problems that can be called market problems are necessarily problems of coordinating or cooperation. 48 00:05:46.000 --> 00:05:51.000 They cannot be characterized as problems of aggregate things. 49 00:05:51.000 --> 00:06:00.000 To continue then into the theory, let's start with a quote from Phillips' original article on the Phillips curve. 50 00:06:00.000 --> 00:06:07.000 He says this, when the demand for a commodity or service is high relative to the supply of it, we expect the price to rise. 51 00:06:07.000 --> 00:06:11.000 The rate of rise being greater, the greater the excess demand. 52 00:06:11.000 --> 00:06:14.000 A couple of points about that statement. 53 00:06:14.000 --> 00:06:19.000 First of all, this is somewhat incorrect as a statement of equilibrium. 54 00:06:19.000 --> 00:06:25.000 When demand is high relative to supply, it makes the price high. 55 00:06:25.000 --> 00:06:32.000 That, in fact, is the indication that prices are a reflection of subjective value, as Mises told us. 56 00:06:32.000 --> 00:06:37.980 and Socialism. High demand relative to supply has nothing to do with changes in prices. 57 00:06:37.980 --> 00:06:42.020 Changes in prices in the market come about through entrepreneurial arbitrage. They come 58 00:06:42.020 --> 00:06:49.120 about through entrepreneurs buying resources at lower prices and combining them in the 59 00:06:49.120 --> 00:06:56.920 market and selling the product at higher prices. In addition to that, the rate of change of 60 00:06:56.920 --> 00:07:02.160 price in a market is completely unknown theoretically. This is purely an 61 00:07:02.160 --> 00:07:09.960 empirical matter. Some prices can change very rapidly like stock prices as people 62 00:07:09.960 --> 00:07:15.240 discovered to their dismay. Other prices change more slowly. There's nothing to be 63 00:07:15.240 --> 00:07:20.280 said theoretically without just an ad hoc assumption as to the rate of 64 00:07:20.280 --> 00:07:29.280 with Changes in Prices. And yet, Phillips designed the Phillips Curve to explain the rate of change of price. 65 00:07:29.280 --> 00:07:35.280 In particular, the rate of change of all wages, the collection of wages. 66 00:07:35.280 --> 00:07:40.280 Brings me to my next point. What is the significance of that? 67 00:07:40.280 --> 00:07:48.280 If we build a theory to explain the rate of change of a collection of wages, what significance does this have? 68 00:07:48.280 --> 00:07:54.640 Why do we want to know what determines the rate of change of a collection of prices? 69 00:07:54.640 --> 00:08:01.520 Notice that has no significance in determining the coordination on the market. 70 00:08:01.520 --> 00:08:06.800 When individuals go into voluntary exchange and begin to attempt to coordinate their activities 71 00:08:06.800 --> 00:08:11.640 with other people, prices emerge as an outcome of that. 72 00:08:11.640 --> 00:08:18.260 Prices are not formed outside of this process that people engage in in an attempt to coordinate 73 00:08:18.260 --> 00:08:23.620 with other people. Once those prices exist as data, then they can be combined 74 00:08:23.620 --> 00:08:27.220 mathematically into any kind of construct. You can add them together, you 75 00:08:27.220 --> 00:08:31.780 can subtract them, you can divide them into each other, etc. Some of those 76 00:08:31.780 --> 00:08:37.260 constructs are meaningful economically and some are not. One that certainly is 77 00:08:37.260 --> 00:08:41.520 meaningful is economic profit. Certainly meaningful, in other words, to multiply 78 00:08:41.520 --> 00:08:47.060 prices times quantities of output and resources to subtract the two to make 79 00:08:47.060 --> 00:08:49.460 Bank Economic Calculation. 80 00:08:49.460 --> 00:08:57.580 On the other hand, the price indexes that are used in Phillips Curve presentations are 81 00:08:57.580 --> 00:08:59.820 economically arbitrary. 82 00:08:59.820 --> 00:09:06.220 There's no more reason to, for example, to get a collection of wages than there is a 83 00:09:06.220 --> 00:09:09.340 collection of the prices of capital goods. 84 00:09:09.340 --> 00:09:13.500 If we are to say, if we want, in other words, to explain the rate of change and the price 85 00:09:13.500 --> 00:09:16.820 of wages, why not of capital goods? 86 00:09:16.820 --> 00:09:22.480 Why don't we construct another theory which tells us or explains for us how the prices 87 00:09:22.480 --> 00:09:30.360 of land change? Or why do we take all labor together? Why don't we take some subset and 88 00:09:30.360 --> 00:09:39.220 explain why or how there's a certain rate of change in the wages of manual labor or 89 00:09:39.220 --> 00:09:44.680 management or something else? The reason we don't do that is because those things have 90 00:09:44.680 --> 00:09:51.680 and I would argue that the same thing is true about the Phillips curve itself, at least as presented by Phillips. 91 00:09:51.680 --> 00:10:05.680 Lipsy, who wrote an article in 1960 following Phillips, tried to integrate in Phillips' work more into the mainstream, 92 00:10:05.680 --> 00:10:12.680 and he provided this as an explanation of why it was important to explain this phenomena that he called the Phillips curve. 93 00:10:12.680 --> 00:10:21.680 He says, this relationship between wage inflation and the unemployment rate is an extremely simple one and it holds considerable promise for empirical testing. 94 00:10:21.680 --> 00:10:35.680 So we are presumably under this thesis to ignore all theory, especially praxeological theory, and substitute only those things we can test. 95 00:10:35.680 --> 00:10:41.680 And the simpler the better, easier to test. 96 00:10:41.680 --> 00:10:55.680 Lipsy then, as I mentioned, attempted to reconcile, a little bit more directly, Phillips' original work and he said this about the theory of the Phillips curve. 97 00:10:55.680 --> 00:11:02.680 He said, we now introduce a dynamic hypothesis that the rate at which the wage changes is related to the excess demand. 98 00:11:02.680 --> 00:11:08.680 And specifically, the greater is the proportionate disequilibrium, the more rapidly will wages be changing. 99 00:11:08.680 --> 00:11:12.840 For this relation to be observed, it is necessary only that there be an unchanging adjustment 100 00:11:12.840 --> 00:11:18.680 mechanism in the market, i.e. that a given excess demand should cause a given rate of 101 00:11:18.680 --> 00:11:19.680 change of price. 102 00:11:19.680 --> 00:11:25.520 I'd like to go through a couple of point highlights about that. 103 00:11:25.520 --> 00:11:34.760 One is that the Phillips-Lipsy original work was clearly a disequilibrium phenomena, unlike 104 00:11:34.760 --> 00:11:41.760 The Keynesian work, or at least some interpretations of Keynes, who viewed this as an equilibrium theory. 105 00:11:41.760 --> 00:11:52.760 In addition to that, Lipsy here is making the assumption that, an ad hoc assumption, that there is an unchanging adjustment mechanism in the market. 106 00:11:52.760 --> 00:12:05.760 And then finally, Lipsy makes another assumption that at equilibrium, there is a certain level of what he calls frictional unemployment. 107 00:12:05.760 --> 00:12:11.760 This is the diagram he uses to construct the theoretical presentation of the Phillips curve, 108 00:12:11.760 --> 00:12:17.760 where the labor market is in the upper diagram and the Phillips relationship in the lower diagram. 109 00:12:17.760 --> 00:12:28.760 And essentially, again, what he's saying is that at point A, there is a certain level of unemployment given on the diagram at point A in the bottom panel. 110 00:12:28.760 --> 00:12:39.760 And that amount is what he calls frictional. That's the amount of unemployment that is unrelated to the condition of either excess supply or excess demand in the labor market itself. 111 00:12:39.760 --> 00:12:46.760 Now, a couple of points about this in terms of criticism of this particular presentation of Lipsy. 112 00:12:46.760 --> 00:12:54.460 One is that, again, it's simply ad hoc to say that there's an unchanging adjustment mechanism in the market. 113 00:12:54.460 --> 00:12:59.660 It's simply incorrect that whatever happens in the market happens according to human action. 114 00:12:59.660 --> 00:13:06.260 Individuals bring about these adjustments, and there must be some explanation of how individuals do this. 115 00:13:06.260 --> 00:13:10.860 And again, the explanation is entrepreneurial arbitrage based upon economic calculation. 116 00:13:10.860 --> 00:13:14.160 That there is an adjustment mechanism, so to speak, in the market, 117 00:13:14.160 --> 00:13:21.660 And there is also the underlying desire to be adjusted, that is for coordination to come about on the market. 118 00:13:21.660 --> 00:13:30.160 Another thing, and Professor Hoppe has pointed this out already, and this is here simply a theoretical point. 119 00:13:30.160 --> 00:13:36.460 The theory of equilibrium is one of what I call perfect coordination. 120 00:13:36.460 --> 00:13:42.660 There is no such thing as either excess demand or excess supply at equilibrium. 121 00:13:42.660 --> 00:13:46.980 This is the way we teach equilibrium analysis as economists, of course. 122 00:13:46.980 --> 00:13:54.660 We say, at wages higher than the equilibrium wage, like W0, there's excess supply. 123 00:13:54.660 --> 00:13:56.740 There's discoordination in the market. 124 00:13:56.740 --> 00:14:00.660 At wages down here, like W1, there's excess demand. 125 00:14:00.660 --> 00:14:03.380 But at the equilibrium wage, there's none of these things. 126 00:14:03.380 --> 00:14:05.700 There's perfect coordination. 127 00:14:05.700 --> 00:14:11.140 Now, Lipsy, again, what he's saying is that we need to, I guess, redefine equilibrium 128 00:14:11.140 --> 00:14:17.940 So that at point A, equilibrium on the diagram, we actually have dis-coordination, we have unemployment. 129 00:14:17.940 --> 00:14:20.140 He calls it again, frictional. 130 00:14:20.140 --> 00:14:25.640 But the equilibrium construct is not designed that way. Equilibrium means perfect coordination. 131 00:14:25.640 --> 00:14:28.740 I think Professor Hoppe has discussed that in more detail. 132 00:14:28.740 --> 00:14:33.540 Notice if we make the assumption then that we're going to stick with that definition of equilibrium, 133 00:14:33.540 --> 00:14:40.140 that at point A, we have perfect coordination, then the actual Phillips curve would look like this. 134 00:14:40.140 --> 00:14:48.840 We'd have to extend the horizontal axis and write negative unemployment on this axis to the left of zero. 135 00:14:48.840 --> 00:14:53.840 And the Phillips curve would actually run down through this point, where this would be point A. 136 00:14:53.840 --> 00:15:02.240 This would be an area of excess demand on the market, this an area of excess supply. 137 00:15:02.240 --> 00:15:05.840 And again, that's not exactly what Phillips had in mind. 138 00:15:05.840 --> 00:15:08.240 In other words, that is not the traditional Phillips trade-off. 139 00:15:08.240 --> 00:15:38.240 there is no trade-off there but let's just continue to go along with Phillips definition and say okay frictional unemployment does exist at point A then what can we say about theoretically within the framework of equilibrium as we understand it and teach it as economists about the Phillips relationship notice again we'll grant Phillips point that at point A we have some positive amount of unemployment we'll call frictional now as the wage 140 00:15:38.240 --> 00:15:50.240 When the rate increases above that level, these individuals that are brought into the market at higher wages, like W-0, that are induced into the market, are all unemployed. 141 00:15:51.240 --> 00:16:00.240 The level of employment is given along by these points on the demand curve. That's the actual amount of employment in the market. 142 00:16:01.240 --> 00:16:07.240 So, one for one, as individuals enter this market at higher wages to try to find jobs, they are unemployed. 143 00:16:08.240 --> 00:16:38.240 infers that the unemployment rate is increasing from the frictional level and so we do have this section of the Phillips curve that Phillips draws downward to the right because at this point the wage, in order to adjust the equilibrium would have to fall, we have a negative wage inflation and at the same time we have greater rates of unemployment because each additional individual brought into the market is unemployed so the unemployment rate must go up. In other words 144 00:16:38.240 --> 00:16:44.120 In other words, the labor force is increasing one for one with the number of unemployed. 145 00:16:44.120 --> 00:16:48.840 But what happens when we move back down the supply relationship? 146 00:16:48.840 --> 00:16:52.960 When we reach point A again, if we're moving back down this way, when we reach point A, 147 00:16:52.960 --> 00:16:56.200 we have a frictional level of unemployment. 148 00:16:56.200 --> 00:17:04.580 Now as we move to wages below that, what must necessarily be true about the individuals 149 00:17:04.580 --> 00:17:07.800 who are now dropping out of the labor force? 150 00:17:07.800 --> 00:17:14.800 If we start with a frictional amount of unemployment at point A, these individuals, as the wage falls and we move to these points on the supply curve, 151 00:17:14.800 --> 00:17:24.800 what can we say about the individuals who were employed at point A as opposed to the number of individuals employed back at the wage W-1? 152 00:17:24.800 --> 00:17:32.800 Well, notice those individuals, unless we are willing to make some other assumption about frictional unemployment, those individuals must have been employed at point A. 153 00:17:32.800 --> 00:17:37.700 If there's a given amount of frictional unemployment and no unemployment, no other type of unemployment, 154 00:17:37.700 --> 00:17:44.000 then as people drop out of the labor force as the wage goes down, they're taking leisure now instead of work. 155 00:17:44.000 --> 00:17:47.000 Those individuals were employed. 156 00:17:47.000 --> 00:17:52.500 And so the amount of frictional unemployment is the same while the labor force is shrinking. 157 00:17:52.500 --> 00:17:59.000 Notice that would make the Phillips curve do this, which again is not the traditional trade-off, right? 158 00:17:59.000 --> 00:18:03.600 In other words, inflation and unemployment would increase together under that scenario. 159 00:18:05.300 --> 00:18:11.500 And Phillips provides no mechanism by which the frictional amount of unemployment decreases 160 00:18:11.500 --> 00:18:17.300 as the extent of excess demand grows, that is, as we move to lower wages on the diagram. 161 00:18:19.800 --> 00:18:27.100 One more point about this theoretically, even if we're willing to grant to the Phillips-Lipsy argument 162 00:18:27.100 --> 00:18:34.300 that frictional unemployment can be reduced as we move to greater and greater levels of excess demand. 163 00:18:34.300 --> 00:18:44.800 It still doesn't hold that wage inflation and unemployment data can be generated by this representation of the labor market. 164 00:18:44.800 --> 00:18:53.800 The reason is because the rate of wage inflation is what we might call a flow variable. 165 00:18:53.800 --> 00:19:02.800 It occurs, it is only measured over some period of time, whereas the unemployment rate is a stock variable measured at a point in time. 166 00:19:02.800 --> 00:19:11.800 And notice on the diagram, we cannot create both wage inflation and a given level of unemployment simultaneously. 167 00:19:11.800 --> 00:19:20.800 If we start, for example, at W1 with some amount of excess demand given on the diagram, let's say by the difference between C and D, 168 00:19:20.800 --> 00:19:26.800 That will give us a level of unemployment and a level of the wage rate. 169 00:19:26.800 --> 00:19:33.800 Now, if we assume, in order to generate, we must assume that the wage is going to change, it's going to increase, 170 00:19:33.800 --> 00:19:41.300 so the wage is going to increase back to the equilibrium level, then that change in the wage will generate wage inflation. 171 00:19:41.300 --> 00:19:46.300 But notice, it also generates a change in the rate of unemployment. 172 00:19:46.300 --> 00:19:53.300 As we move from a wage of W1 at point C and D, back to point A, we have less unemployment. 173 00:19:53.300 --> 00:20:00.300 So the only thing the diagram, the only thing the theory can generate are either levels of the wage and levels of unemployment, 174 00:20:00.300 --> 00:20:04.300 or changes in the wage and changes in unemployment. 175 00:20:04.300 --> 00:20:11.300 The Phillips Curve, on the other hand, tries to correlate changes in the wage rate with levels of unemployment. 176 00:20:11.300 --> 00:20:16.300 The Theory simply can't do that. It's incapable. 177 00:20:16.300 --> 00:20:22.300 Now, as an alternative, let's try the Keynesian presentation, 178 00:20:22.300 --> 00:20:29.300 and with some misgivings about this, especially after Professor Garrison's discussion, 179 00:20:29.300 --> 00:20:38.300 because it's somewhat unclear as to what exactly Keynes meant in this area of the labor market. 180 00:20:38.300 --> 00:20:53.300 I like the quote, I believe, by James Tobin out of Seymour Harris's book, The New Economics, where he says it's impossible to find a representation of Keynes' work that is both comprehensible and true to the original. 181 00:20:53.300 --> 00:21:01.300 Anyway, it seems that Keynes had something like this in mind. 182 00:21:01.300 --> 00:21:09.300 First of all, he seems to imply that this is an equilibrium theory, that his theory of employment is an equilibrium one. 183 00:21:09.300 --> 00:21:16.300 He says, the volume of employment is given by the point of intersection between the aggregate demand function and the aggregate supply function. 184 00:21:16.300 --> 00:21:19.300 Traditionally, it's what we call equilibrium. 185 00:21:19.300 --> 00:21:25.300 In addition, employment depends upon aggregate demand in the Keynesian view. 186 00:21:25.300 --> 00:21:33.300 Again, quoting from Keynes, he says the object of the employment function is to relate the amount of effective demand with the amount of employment. 187 00:21:33.300 --> 00:21:46.300 And finally, again, with some misgivings about this, Keynes seems to imply, and most of his followers embodied this idea, that money wages do not readily adjust downward. 188 00:21:46.300 --> 00:21:51.300 If you read Keynes, he seems to imply that in two ways. 189 00:21:51.300 --> 00:21:55.300 is one that workers simply weren't willing to take money wage cuts. 190 00:21:55.300 --> 00:21:59.300 He says, while workers will usually resist a reduction of money wages, 191 00:21:59.300 --> 00:22:05.300 it is not their practice to withdraw their labor whenever there is a rise in the price of wage goods. 192 00:22:05.300 --> 00:22:11.300 He also thought that workers may be unable to lower the money wage. 193 00:22:11.300 --> 00:22:16.300 He says, again, except in a socialized community where wage policy is settled by decree, 194 00:22:16.300 --> 00:22:22.540 There is no means of securing uniform wage reduction for every class of labor. 195 00:22:22.540 --> 00:22:29.020 If we follow those particular prescriptions then for the labor market, again this is not 196 00:22:29.020 --> 00:22:33.780 the only way to interpret Keynes's view of the labor market, it would look something 197 00:22:33.780 --> 00:22:34.780 like this. 198 00:22:34.780 --> 00:22:42.940 This is a diagram lifted from Leontief's presentation in Seymour Harris's The New Economics of Keynes's 199 00:22:42.940 --> 00:22:45.560 labor market. 200 00:22:45.560 --> 00:22:52.600 The inelastic portion of the supply of labor represents Keynes' assumption that workers 201 00:22:52.600 --> 00:22:58.640 will not accept a reduction in their money wage, that they would rather accept less employment 202 00:22:58.640 --> 00:23:05.920 represented by point A, refusing to accept the lower money wage. 203 00:23:05.920 --> 00:23:12.820 Then on the diagram, Leontief at least claims that point F is the point of full employment. 204 00:23:12.820 --> 00:23:26.320 Any aggregate demand then that would leave demand for labor short of full employment would result in a level of involuntary unemployment as the difference between point A and point F. 205 00:23:26.320 --> 00:23:34.820 Again, without going into this theory in any kind of detail, Professor Hoppe has talked about some of these ideas already. 206 00:23:34.820 --> 00:23:42.320 I would just like to present some of the criticisms in terms of the Phillips curve, what this has to do with the Phillips curve. 207 00:23:42.320 --> 00:23:50.020 First of all, an equilibrium theory, unlike the Phillips ellipse, disequilibrium theory, 208 00:23:50.020 --> 00:23:56.360 cannot generate, without additional assumptions, the necessary data of the Phillips curve. 209 00:23:56.360 --> 00:24:02.080 It cannot generate changes in the wage rate and unemployment rates. 210 00:24:02.080 --> 00:24:07.860 All equilibrium theory can do is generate levels of those things. 211 00:24:07.860 --> 00:24:15.020 In addition, if we add the assumption about changing aggregate demand affecting the labor 212 00:24:15.020 --> 00:24:20.620 market in the way Keynes envisions it, then the Phillips curve, if we were to draw the 213 00:24:20.620 --> 00:24:25.220 Phillips curve according to this diagram, let's say we start at point A with a certain 214 00:24:25.220 --> 00:24:30.220 level of demand for labor based on aggregate demand and aggregate demand increases and 215 00:24:30.220 --> 00:24:37.100 hence labor demand expands and employment increases, lowering the level of unemployment. 216 00:24:37.100 --> 00:24:41.380 Notice, nothing happens to the wage. The money wage stays the same. 217 00:24:41.380 --> 00:24:45.100 So we don't get no trade-off here at all. In fact, all we would get if we were to draw 218 00:24:45.100 --> 00:24:51.340 it would be the horizontal axis of the diagram. That is to say, this would be a wage inflation 219 00:24:51.340 --> 00:24:56.700 of zero, would be consistent with various levels of unemployment as we move along the 220 00:24:56.700 --> 00:25:04.140 inelastic section of labor supply. Then when we reach point F, if demand were to be increased 221 00:25:04.140 --> 00:25:08.060 beyond point F by an increase in aggregate demand. 222 00:25:08.060 --> 00:25:10.340 It's somewhat uncertain as to what happens in this case, 223 00:25:10.340 --> 00:25:12.140 but if by full employment, 224 00:25:12.140 --> 00:25:15.260 Keynes means nobody else can be employed, 225 00:25:15.260 --> 00:25:18.140 and again, it's not clear that that's what he meant, 226 00:25:18.140 --> 00:25:19.820 then the rest of the Phillips diagram 227 00:25:19.820 --> 00:25:22.020 would just be a vertical line 228 00:25:22.020 --> 00:25:25.140 with wage inflation on the vertical axis 229 00:25:25.140 --> 00:25:27.180 because nothing would happen to the unemployment rate 230 00:25:27.180 --> 00:25:30.060 as the wage was driven up past point F. 231 00:25:30.060 --> 00:25:34.020 Again, there may be some other interpretations 232 00:25:34.020 --> 00:25:41.100 of the Keynes. But again, the diagram provided by Leontief cannot give us the Phillips relationship. 233 00:25:41.100 --> 00:25:50.300 And of course, in a more general way, the Phillips trade-off was a great setback for 234 00:25:50.300 --> 00:25:55.260 the Keynesians. They didn't want a trade-off. The Keynes and Hansen, some of the other earlier 235 00:25:55.260 --> 00:25:59.100 Keynesians believed that you could just increase aggregate demand right up to the point of 236 00:25:59.100 --> 00:26:04.420 full employment with no inflation. There was no inflation trade-off. If you went beyond 237 00:26:04.420 --> 00:26:10.900 that point, King said, prices would rise without limit. That is, it was like a light switch. 238 00:26:10.900 --> 00:26:18.660 There was no trade-off. It was just either all unemployment or all inflation. 239 00:26:18.660 --> 00:26:26.420 Now one other point to make, and I don't want to dwell on this for any length of time 240 00:26:26.420 --> 00:26:56.420 because it doesn't have much to do with the Keynesian myth but neoclassical economists and others that have been talked about have attempted also to provide theories to explain the Phillips curve and as I'll go into in a minute that that effort has all been wasted because there is no Phillips curve but anyway the the neoclassical work of if I may call it that of Phelps, Friedman, etc. is I believe 241 00:26:56.420 --> 00:27:03.420 I believe an attempt to blend Cain's work with the original disequilibrium view of Phillips and Lipsy. 242 00:27:03.420 --> 00:27:11.420 It's an attempt to integrate aggregate demand, not into an equilibrium construct, but a disequilibrium one, 243 00:27:11.420 --> 00:27:18.420 where there are some additional assumptions provided by Phelps as to what happens in the disequilibrium state. 244 00:27:18.420 --> 00:27:31.420 He says this, the frictions in an advanced economy create a linkage between the path of the unemployment rate over time and the path of the inflation rate generated by the course of aggregate demand. 245 00:27:31.420 --> 00:27:41.420 These frictions then in turn stem from faulty information, bad information, and are modeled in this work by search theories of the labor market 246 00:27:41.420 --> 00:27:48.420 and certain assumptions about how individuals adapt to this uncertainty that they face in the market. 247 00:27:48.420 --> 00:27:52.420 Just a couple of points about this, again, without going into detail. 248 00:27:52.420 --> 00:27:56.420 The adaptive expectation assumption is completely arbitrary. 249 00:27:56.420 --> 00:28:02.420 Just like all other ad hoc assumptions about labor market adjustments or adjustments in any other market, 250 00:28:02.420 --> 00:28:04.420 adjustments come about through human action. 251 00:28:04.420 --> 00:28:10.420 They come about through entrepreneurial arbitrage based upon people's calculation of profit. 252 00:28:10.420 --> 00:28:19.420 doesn't further our knowledge about how the real world works to simply assume that it works a particular way and especially a mechanistic way. 253 00:28:19.420 --> 00:28:36.420 In addition to that, it doesn't advance our knowledge very much either for the neoclassical economist to replace the homo economicus of classical economics with the homo ignoramus of neoclassical economics. 254 00:28:36.420 --> 00:28:46.920 Ludwig von Mises told us a long time ago that the correct view is homo agena, that man is the acting animal, that's the correct representation. 255 00:28:46.920 --> 00:29:02.420 Also, it has always seemed somewhat paradoxical to me that the Keynesian view of this Phillips curve literature has aggregate demand determining optimal employment. 256 00:29:02.420 --> 00:29:07.920 Aggregate demand for products determines full employment or optimal employment, 257 00:29:07.920 --> 00:29:13.120 whereas the Phelps-Freedman literature, which focuses on adjustments in the labor market, 258 00:29:13.120 --> 00:29:15.920 is supposed to tell us about optimal inflation. 259 00:29:15.920 --> 00:29:17.920 It would seem it would be the other way around, 260 00:29:17.920 --> 00:29:21.920 that aggregate demand would be more closely linked with inflation, 261 00:29:21.920 --> 00:29:26.920 and adjustments in the labor market more closely linked with employment and unemployment. 262 00:29:26.920 --> 00:29:31.420 Final point theoretically, and not to go into any detail, but the... 263 00:29:31.420 --> 00:29:44.420 Whatever link there is theoretically between inflation, price inflation, and the unemployment rate can be completely explained or is at least completely consistent with the Misesian theory of the business cycle. 264 00:29:44.420 --> 00:29:58.420 There isn't any need to go beyond that. Mises has already demonstrated that artificial expansion of credit will in fact result in a boom followed by a bust, as Professor Hoppe has already described to us. 265 00:29:58.420 --> 00:30:07.420 Whether or not that will be associated with higher rates of price inflation and lower rates of unemployment 266 00:30:07.420 --> 00:30:13.420 depends upon a multitude of other empirical factors that cannot be predicted in advance. 267 00:30:13.420 --> 00:30:17.420 Sometimes that will happen, sometimes it will not. 268 00:30:17.420 --> 00:30:23.420 There again is no way to know that in advance of the complex of human action that occurs 269 00:30:23.420 --> 00:30:27.420 that generates these prices and these unemployment figures. 270 00:30:27.420 --> 00:30:35.420 Secondly, I'd like to discuss in terms of the Phillips Curve, the data of the Phillips Curve itself. 271 00:30:35.420 --> 00:30:41.420 And then we'll talk about the actual empirical implementation or use of this data. 272 00:30:41.420 --> 00:30:50.420 First of all, in terms of problems with this data, and this I think is somewhat of an underappreciated problem, 273 00:30:50.420 --> 00:30:56.420 this data is produced by government bureaucrats and that ought to take us back a little bit. 274 00:30:56.420 --> 00:31:04.940 We know that government production processes are inefficient. Why do we have this great 275 00:31:04.940 --> 00:31:12.060 faith that the numbers they generate, unemployment, inflation, etc., are written in stone? Where 276 00:31:12.060 --> 00:31:18.900 does this faith come from? It would be certainly more than ironic if sometime in the future 277 00:31:18.900 --> 00:31:25.700 it was revealed that all these numbers were just made up, just invented. I mean economists 278 00:31:25.700 --> 00:31:29.540 Students have spent their whole careers trying to explain the Phillips Curve, and the Phillips 279 00:31:29.540 --> 00:31:35.460 Curve may be nothing more than just a bunch of bureaucrats in a back room generating random 280 00:31:35.460 --> 00:31:36.460 numbers. 281 00:31:36.460 --> 00:31:41.420 I remember again in graduate school, it sounds a little far-fetched, but again in graduate 282 00:31:41.420 --> 00:31:50.580 school, Opel and State brought in a speaker who used to be sort of a middle-level bureaucrat 283 00:31:50.580 --> 00:31:55.180 in the Bureau of Labor Statistics, and he used to be involved in the calculation of 284 00:31:55.180 --> 00:32:02.220 Unemployment Rate, and he told us, presumably never thinking anyone would ever repeat this, 285 00:32:02.220 --> 00:32:10.500 that he was wrong, that sometimes when they go through the calculation, they get the surveys 286 00:32:10.500 --> 00:32:15.020 back and they crunch out the numbers, that the numbers would come out wild. 287 00:32:15.020 --> 00:32:20.400 You get an unemployment rate of 25%, you know, when it had been seven or six. 288 00:32:20.400 --> 00:32:25.400 And he said when those things were sent on to the top muck mucks, the unemployment rate 289 00:32:25.400 --> 00:32:32.820 would be published at 7.5. And they used to have a joke apparently about this in his circles. 290 00:32:32.820 --> 00:32:44.620 They called this invoking the omega factor. Another problem, it seems to me, with allowing 291 00:32:44.620 --> 00:32:50.220 and Government Bureaucrats to produce this information for us is that this is politically 292 00:32:50.220 --> 00:32:58.340 sensitive information. This type of information makes and breaks political campaigns and careers 293 00:32:58.340 --> 00:33:03.620 and it's certainly not beyond the realm of possibility that it would be deliberately 294 00:33:03.620 --> 00:33:08.420 manipulated for political gain. And again, Reagan's, the Reagan administration's manipulation 295 00:33:08.420 --> 00:33:14.460 of the CPI is a pretty good example of that. Economists are fond of talking about the political 296 00:33:14.460 --> 00:33:19.460 The mathematical business cycle where government officials manipulate the levers in order to create good numbers, 297 00:33:19.460 --> 00:33:22.460 but it's much simpler just to manipulate the numbers themselves. 298 00:33:22.460 --> 00:33:33.460 Second data problem is that this data is aggregated, 299 00:33:33.460 --> 00:33:39.460 and you've heard much about the theoretical difficulties that aggregation creates already, 300 00:33:39.460 --> 00:33:59.460 And I won't go into that in detail, but just to point out again that when you aggregate prices, you wipe out the information that's necessary to understand what is going on in a relative sense as people attempt to coordinate themselves in the marketplace. 301 00:33:59.460 --> 00:34:09.460 Also, part of this aggregation process is aggregating unemployment figures into one number across all industries. 302 00:34:09.460 --> 00:34:15.960 And again, if you disaggregate that, you find that unemployment varies widely across different industries, 303 00:34:15.960 --> 00:34:23.460 across different geographic locations, etc., which poses something of a problem for the Phillips curve doctrine, 304 00:34:23.460 --> 00:34:25.460 especially the Keynesian view of it. 305 00:34:25.460 --> 00:34:28.740 And aggregate demand or lack of it is what causes unemployment. 306 00:34:28.740 --> 00:34:31.460 Why do we get these differences? 307 00:34:31.460 --> 00:34:32.780 Why relative differences? 308 00:34:32.780 --> 00:34:38.220 Why more unemployment for young teenagers? 309 00:34:38.220 --> 00:34:42.700 Why more unemployment in auto industry in certain times, et cetera? 310 00:34:42.700 --> 00:34:47.460 That begs for an answer that can be provided only by observing and analyzing these relative 311 00:34:47.460 --> 00:34:48.460 differences. 312 00:34:48.460 --> 00:34:55.100 In addition to that, though, aggregation creates an econometric problem, creates a problem 313 00:34:55.100 --> 00:35:05.700 In terms of estimating, as economists attempt to generate equations for the Phillips curve, 314 00:35:05.700 --> 00:35:14.220 briefly without going into trying to reproduce this in detail, when the least squares procedure 315 00:35:14.220 --> 00:35:19.780 is used to estimate a regression line, which is what is done with the Phillips curve, the 316 00:35:19.780 --> 00:35:25.220 The information that is used to generate the line is variation. 317 00:35:25.220 --> 00:35:31.740 What is actually done is a mean of unemployment would be calculated and then the line is fitted 318 00:35:31.740 --> 00:35:37.100 in order to minimize the variation of the actual data from this mean. 319 00:35:37.100 --> 00:35:40.900 Now when you aggregate data, you destroy this variation. 320 00:35:40.900 --> 00:35:45.860 When you sum data into one number, let's say you have 12 unemployment numbers each year 321 00:35:45.860 --> 00:35:51.220 here, and you sum them into one, you destroy information in an econometric sense. 322 00:35:51.220 --> 00:35:58.060 And it's only that type of information that can allow econometric estimation to be proper. 323 00:35:58.060 --> 00:36:05.500 If you aggregate data, then all of your equation estimations become biased. 324 00:36:05.500 --> 00:36:10.100 In fact, there really isn't anything you can say at all about the estimates with Phillips 325 00:36:10.100 --> 00:36:16.540 Phillips Curve data because they have been aggregated into one data point per year when 326 00:36:16.540 --> 00:36:20.140 in fact the government generates this data monthly. 327 00:36:20.140 --> 00:36:24.100 And it generates the data across different industries. 328 00:36:24.100 --> 00:36:29.860 And if econometrically to be correct, if economists wanted to find the actual Phillips relationship, 329 00:36:29.860 --> 00:36:33.020 they would have to use this disaggregated data. 330 00:36:33.020 --> 00:36:36.740 It's simply econometrically wrong to aggregate data, it destroys information and it makes 331 00:36:36.740 --> 00:36:48.740 and of course it is always improper to purposefully aggregate data, to intentionally aggregate it, which we'll see Phillips does. 332 00:36:48.740 --> 00:36:58.740 Third, there tends to be a misinterpretation of the data, of the Phillips trade-off. 333 00:36:58.740 --> 00:37:04.740 The first part of that misinterpretation is to display the data on a two-dimensional scatter diagram. 334 00:37:04.740 --> 00:37:10.140 Diagram. The Phillips Curve data is not generated, as we mentioned before, statistically and 335 00:37:10.140 --> 00:37:18.380 it cannot be represented correctly as a two-dimensional process. It at least is a three-dimensional 336 00:37:18.380 --> 00:37:25.580 process where time has to be taken into account in the display of the data. This is a reproduction 337 00:37:25.580 --> 00:37:33.160 of the Phillips Curve that I took from, Phillips Curve points, that I took from the Economic 338 00:37:33.160 --> 00:37:37.160 The 1988 edition of The Economic Report of the President. 339 00:37:37.160 --> 00:37:46.160 Now, the point here isn't to necessarily find the Phillips curve in all the points, 340 00:37:46.160 --> 00:37:51.160 but you should notice, by the way, that you can't readily do that. 341 00:37:51.160 --> 00:37:55.160 I mean, you can find all sorts of shapes in here if you look for them. 342 00:37:55.160 --> 00:38:00.160 But the point is here, simply, that the Phillips curve is falsified, 343 00:38:00.160 --> 00:38:11.160 This proposition that unemployment and inflation move negatively to one another is falsified almost half the time in this 20-year period. 344 00:38:11.160 --> 00:38:15.160 For example, 80 to 81, we have a positive relationship. 345 00:38:15.160 --> 00:38:21.160 The data, in other words, moves sequentially and you cannot display it as a two-dimensional diagram. 346 00:38:21.160 --> 00:38:25.160 You have to take into account the fact that you move through time from one point to another. 347 00:38:25.160 --> 00:38:28.160 And when you do that, sometimes the relationship is positive. 348 00:38:28.160 --> 00:38:32.960 Sometimes inflation and unemployment increase together, sometimes they decrease together. 349 00:38:32.960 --> 00:38:39.460 82, 83 is another example, 83, 84, 84, 85, 85, 86. 350 00:38:39.460 --> 00:38:45.460 And you can find numerous other examples where when you move from one year to the next, the relationship is positive. 351 00:38:45.460 --> 00:38:52.460 And again, this is simply a misinterpretation of the data to draw a line, a Phillips curve line through here, 352 00:38:52.460 --> 00:38:59.460 and say that regardless of the sequence of the movement of these data points, we have a negative relationship. 353 00:38:59.460 --> 00:39:07.460 In actual fact, almost half the time on this diagram, as you move from one year to the next, it's a positive relationship. 354 00:39:07.460 --> 00:39:13.460 Notice another point about that is that you cannot predict, even if you were to run an estimation of this 355 00:39:13.460 --> 00:39:19.460 and come up with a negative coefficient between inflation and unemployment, you cannot predict from year to year what's going to happen. 356 00:39:19.460 --> 00:39:27.460 It doesn't really matter if there's a Phillips relationship in here on an average sense, in an econometric sense. 357 00:39:27.460 --> 00:39:32.460 What's important for government policy and what's important in a theoretical sense is, 358 00:39:32.460 --> 00:39:38.460 can we know with today's numbers of inflation and unemployment what tomorrow's numbers will be? 359 00:39:38.460 --> 00:39:45.460 Can we know if we do certain things that will move from higher inflation and lower unemployment to vice versa? 360 00:39:45.460 --> 00:39:49.460 Or will we, in fact, end up moving to higher inflation and higher unemployment both? 361 00:39:49.460 --> 00:39:56.460 And that certainly can't be precluded. In fact, that's somewhat of a normal occurrence as you look at the scatter diagram itself. 362 00:39:56.460 --> 00:40:04.460 One other point about misinterpretation of the data, as mentioned before in just a little bit more detail. 363 00:40:04.460 --> 00:40:07.460 These data points are not generated statistically. 364 00:40:07.460 --> 00:40:16.460 Statistically, data points are generated in a complex set of interactions between hundreds of millions of different individuals. 365 00:40:16.460 --> 00:40:24.460 And it's simply a misinterpretation to view this data in a unilateral, simple statistical way. 366 00:40:24.460 --> 00:40:32.460 It is neither, as Mises has already pointed out, it is neither repeatable, that is to say data that is brought about through history is unique. 367 00:40:32.460 --> 00:40:36.460 Each data point is generated in a unique sense. 368 00:40:36.460 --> 00:40:42.780 Statistical data, of course, must be repeatable, like flipping a coin or things of that type. 369 00:40:42.780 --> 00:40:44.580 It is also not random. 370 00:40:44.580 --> 00:40:49.440 This data is generated by motivated human beings who are attempting to accomplish something. 371 00:40:49.440 --> 00:40:53.820 All statistical information is generated randomly. 372 00:40:53.820 --> 00:40:55.420 That's a foundation of it. 373 00:40:55.420 --> 00:41:00.340 It's also generated, well, at least if you're going to use econometrics, this data must 374 00:41:00.340 --> 00:41:03.300 be generated according to a normal curve. 375 00:41:03.300 --> 00:41:06.020 The error must be distributed normally. 376 00:41:06.020 --> 00:41:14.060 And as Professor Rothbard has recently discovered, well, not to say that he only recently knew 377 00:41:14.060 --> 00:41:17.980 this, but recently discovered work that had demonstrated that the world is not normally 378 00:41:17.980 --> 00:41:18.980 distributed. 379 00:41:18.980 --> 00:41:25.940 It's not something that is difficult to believe, but that actual estimations have been made 380 00:41:25.940 --> 00:41:32.980 of the underlying statistical foundations of certain processes, and they're not normal. 381 00:41:32.980 --> 00:41:50.980 Then to turn to estimation to the process that Phillips and others have used to actually make an estimate of the Phillips relationship, Phillips says this in his original work, 382 00:41:50.980 --> 00:41:59.980 The purpose is to see whether statistical evidence supports the hypothesis that the rate of change of money wages can be explained by the level of unemployment. 383 00:41:59.980 --> 00:42:05.980 And a couple of points about that, and this is a widespread misconception about econometrics. 384 00:42:05.980 --> 00:42:09.980 Econometrics, first of all, can't explain anything. 385 00:42:09.980 --> 00:42:16.980 What econometrics does is show how variation in one variable is correlated with variation in another. 386 00:42:16.980 --> 00:42:21.980 It provides only correlation, not explanation. 387 00:42:21.980 --> 00:42:25.980 Explanation must be provided by economic theory. 388 00:42:25.980 --> 00:42:32.980 For example, there may be a very high correlation between the number of dishes washed in a restaurant per day 389 00:42:32.980 --> 00:42:36.980 and the total receipts that are received in that restaurant per day, 390 00:42:36.980 --> 00:42:43.980 but that is no theory which says that more dirty dishes causes more receipts to come into the restaurant. 391 00:42:43.980 --> 00:42:53.980 Another point about, implicit in that statement, econometrics only tells us about variation. 392 00:42:53.980 --> 00:42:59.980 It tells us nothing about whether levels of variables move together or whatever. 393 00:42:59.980 --> 00:43:04.980 It tells us only when one variable moves, does another one move with it. 394 00:43:04.980 --> 00:43:11.980 It cannot tell us anything about if wage inflation is high, is unemployment at a certain level. 395 00:43:11.980 --> 00:43:27.980 In addition, Phillips goes on to say this, that there's a clear tendency for the rate of change of money wages to be high when unemployment is low and to be low or negative when unemployment is high. 396 00:43:27.980 --> 00:43:32.980 This is a reproduction of Phillips scatter diagram from which he made that statement. 397 00:43:32.980 --> 00:43:35.980 And I would personally take contention with that statement. 398 00:43:35.980 --> 00:43:38.980 I don't think that diagram shows anything of a sort. 399 00:43:38.980 --> 00:43:49.980 of a sort, I don't think you can look at those points and say, without any debate, that it shows that the money wage rate is high when the unemployment rate is low. 400 00:43:49.980 --> 00:44:04.980 In fact, if you eliminate a couple of outlier points up here at the top of the diagram, almost all the points fall in a band, almost uniformly, almost at random through that band. 401 00:44:04.980 --> 00:44:15.480 There's really nothing that can be said before running a test as to whether or not high rates of wage inflation correlate with low rates of unemployment. 402 00:44:15.480 --> 00:44:18.980 In fact, I think it's simply a misstatement. 403 00:44:18.980 --> 00:44:26.980 If you look at any particular level of unemployment, you'll notice that it's consistent with various levels of wage inflation. 404 00:44:26.980 --> 00:44:33.980 Two percent unemployment, for example, is we find a wage inflation that's negative, about a negative half percent. 405 00:44:33.980 --> 00:44:43.480 We find 2%, 3%, 4%, even 7% is not completely inconsistent as a wage inflation number with 2% unemployment. 406 00:44:43.480 --> 00:44:47.980 And the same is true for most of the bulk of the data. 407 00:44:47.980 --> 00:44:55.980 Even if we move out to 6% unemployment, we find wage inflation correlated with it that is widely varied. 408 00:44:55.980 --> 00:44:59.980 Negative rates of inflation, positive rates of inflation. 409 00:44:59.980 --> 00:45:06.860 And so there again isn't anything that can be said unilaterally about a Phillips relationship 410 00:45:06.860 --> 00:45:10.660 from that particular scatter diagram. 411 00:45:10.660 --> 00:45:19.600 In addition to that, the scatter diagram is actually much worse in terms of its interpretation 412 00:45:19.600 --> 00:45:25.940 than it appears here because Phillips has already arbitrarily separated his data. 413 00:45:25.940 --> 00:45:33.180 This is the Phillips diagram for the period 1861 to 1913, but Phillips also has data 414 00:45:33.180 --> 00:45:36.940 from 1913 and 1957 that he doesn't put on this diagram. 415 00:45:36.940 --> 00:45:42.200 And the reason he doesn't do it is because most of the data points are out here. 416 00:45:42.200 --> 00:45:45.380 And there are a few in here and a bunch of them back here. 417 00:45:45.380 --> 00:45:50.740 And if you put it all together, it doesn't really look like much at all. 418 00:45:50.740 --> 00:45:57.900 So there's been, in my opinion, some arbitrary separation of the data. 419 00:45:57.900 --> 00:46:04.900 In addition to that, Phillips goes through some manipulation econometrically to get his 420 00:46:04.900 --> 00:46:06.680 results. 421 00:46:06.680 --> 00:46:12.980 One thing he does, and again this is econometrically incorrect, he assumes a particular form of 422 00:46:12.980 --> 00:46:14.440 the functional relationship. 423 00:46:14.440 --> 00:46:18.260 He assumes that the Phillips curve is log-linear. 424 00:46:18.260 --> 00:46:28.260 And if you know anything about log-linear, that particular form is quite inappropriate for this data because you cannot take the log of negative numbers. 425 00:46:28.260 --> 00:46:33.260 And so you have to eliminate all of the negative numbers in his database. 426 00:46:33.260 --> 00:46:39.260 Then, so he obviously should not assume a log-linear form. It's inappropriate. 427 00:46:39.260 --> 00:46:45.260 In addition to that, Lipsy showed in his article that log-linear is statistically inferior. 428 00:46:45.260 --> 00:46:51.500 He has a different form of the function which actually correlates this data much better than ellipses. 429 00:46:51.500 --> 00:47:01.580 Second, and if you're wondering about the crosses, Phillips does not estimate the Phillips curve with the data points. 430 00:47:01.580 --> 00:47:09.820 He averages these data points into these crosses so that, for example, between the unemployment rate of 2% and 3%, 431 00:47:09.820 --> 00:47:13.620 he averages all of the wage inflation, he comes up with this. 432 00:47:13.620 --> 00:47:20.420 Then he does the same thing between 3% and 4%. He averages all the wage inflation. He comes up with this cross, etc. for the rest of them. 433 00:47:20.420 --> 00:47:27.220 Then he fits his Phillips curve to the four crosses. He just fits the curve in between those four crosses. 434 00:47:27.220 --> 00:47:37.220 The other two crosses provide where the curve passes for one of the other coefficients of his equation. 435 00:47:37.220 --> 00:47:43.520 Not to go into any detail about his equation, but he estimates two of the coefficients with four data points. 436 00:47:43.520 --> 00:47:48.520 And then he estimates the other one with the remaining two outlier crosses. 437 00:47:48.520 --> 00:47:54.520 And again, this is chicanery. You just don't do this econometrically. 438 00:47:54.520 --> 00:48:02.520 You don't aggregate data on purpose to provide for a particular relationship that you're looking for. 439 00:48:02.520 --> 00:48:05.520 That's simply incorrect. 440 00:48:05.520 --> 00:48:24.520 Lipsy then cleaned up some of this mess and actually did a regression estimation for all of this data, all of the 1861 through 1913 data with an equation which allowed him to use the negative points, etc. 441 00:48:24.520 --> 00:48:28.520 He didn't aggregate the data as Phillips did. 442 00:48:28.520 --> 00:48:44.220 Now, if we were just going to sit back before this was done and we wanted to have a kind of metric criteria to determine the correlation coefficient between changes in wage inflation and unemployment, 443 00:48:44.220 --> 00:48:56.320 I mean, how high would it have to be for us to accept a relationship that we're going to make the centerpiece of macroeconomics and the guiding post of government policy? 444 00:48:56.320 --> 00:49:02.320 Would you want it to be 0.99? I mean, at least 0.95, I would think. 445 00:49:02.320 --> 00:49:10.320 Most econometric studies would be laughed out of the room at less than 0.95. 446 00:49:10.320 --> 00:49:13.320 Notice this is especially true for time series data. 447 00:49:13.320 --> 00:49:23.320 There tends generally to be a high trend built into time series data that gives extremely high r-squares for time series data. 448 00:49:23.320 --> 00:49:30.520 When I did my doctoral work, it was in econometrics, and I ran several regressions. 449 00:49:30.520 --> 00:49:32.420 They still haunt me at night. 450 00:49:32.420 --> 00:49:36.520 And the R-squares were extremely high, .99, .98. 451 00:49:36.520 --> 00:49:42.920 If I get an R-square of .96, I'd lay awake at night, you know, worrying about whether it was going to be accepted or not. 452 00:49:42.920 --> 00:49:49.320 Well, anyway, when Lipsy fits this, he gets an R-square of .64. 453 00:49:49.320 --> 00:49:51.620 And remember, that's to the good data. 454 00:49:51.620 --> 00:49:55.620 He actually fits two different curves. 455 00:49:55.620 --> 00:50:02.620 The R-square he gets for the data that looks fairly Phillips-oriented is 0.64, 456 00:50:02.620 --> 00:50:07.620 but when he does this again for the rest of the data, he gets an R-square of 0.28. 457 00:50:07.620 --> 00:50:15.620 Now, personally I wouldn't bet my own career, let alone the whole profession, on R-squares of 0.64 and 0.28. 458 00:50:15.620 --> 00:50:20.620 That's just not very good, especially for time series data. 459 00:50:20.620 --> 00:50:36.620 On the other hand, another article by Samuelson and Solow claimed that this was actually quite remarkable, using their own words, they called these results remarkable. 460 00:50:36.620 --> 00:50:49.620 They said that for the 1861 to 1913 period, there was a fairly close relationship between inflation and unemployment and for the 1919 to 1957, that the curve fit about as well. 461 00:50:49.620 --> 00:50:58.620 And they were so inspired by this, they did their own scatter diagram for U.S. data. It looks like this. 462 00:50:58.620 --> 00:51:04.620 And simply without running any regressions or any other kind of sophisticated process, 463 00:51:04.620 --> 00:51:10.620 they just pronounced the existence of the Phillips Curve, which, in my opinion, takes great faith. 464 00:51:10.620 --> 00:51:18.620 In fact, Samuelson and Solo, from that article, even said, quote, that they're points all over the place. 465 00:51:18.620 --> 00:51:48.620 So how did they get the Phillips curve trade-off? They did it the same way that Phillips and Lipsy did, they arbitrarily separated the data, that's what the blue points are, the blue points are the data for the 1940s and even that data doesn't look real promising for a Phillips curve relationship, then again that's econometrically incorrect, you should just take all the data, lump it together, run your regression and let the chips fall where they may. 466 00:51:48.620 --> 00:51:58.620 One other point of interest about Samuelson and Solo is that this is the beginning of the shifting of the Phillips Curve. 467 00:51:58.620 --> 00:52:04.620 This article is where Samuelson and Solo claim that the Phillips Curve has simply just shifted. 468 00:52:04.620 --> 00:52:09.620 It was back here in the 40s and then it shifted here and then out and out. 469 00:52:09.620 --> 00:52:16.620 And not too surprisingly, that did not set them aback as to whether or not the Phillips Curve really existed. 470 00:52:16.620 --> 00:52:21.320 that simply inspired them to call for more government intervention to keep the Phillips Curve from shifting. 471 00:52:21.320 --> 00:52:24.320 So we have to have a set of government intervention to keep it from shifting, 472 00:52:24.320 --> 00:52:26.820 and then physical monetary policy to move along it. 473 00:52:28.620 --> 00:52:34.920 But econometrically, what a shifting curve means is what econometricians call misspecification. 474 00:52:36.920 --> 00:52:39.120 In more simple terms, it means your equation is wrong. 475 00:52:39.720 --> 00:52:42.920 It's just wrong. That's what shifting means. 476 00:52:42.920 --> 00:53:01.920 And it seems certainly that it would be an act of prudence to wait until we had the right equation before we ran around pulling levers of fiscal and monetary policy to exploit an equation that doesn't exist or we don't know whether it will shift or not. 477 00:53:01.920 --> 00:53:19.920 One other point briefly about the Phillips curve estimation is that neoclassical economists, again I use that term somewhat loosely, have also attempted to explain this shifting, explain the econometric mis-specification of the Phillips relationship. 478 00:53:19.920 --> 00:53:32.920 And they have used, by and large, you'll find this in the textbooks, they've used expected rates of inflation as a potential variable to put into the Phillips relationship to explain the shifting. 479 00:53:32.920 --> 00:53:42.920 And of course, when the expectation of inflation changes, then the Phillips relationship shifts, and in the long run, we get the long-run Phillips curve, the vertical Phillips curve. 480 00:53:42.920 --> 00:53:45.920 Now, econometrically, there's some problems with that. 481 00:53:45.920 --> 00:53:50.420 By far, the most important is you can't quantify expectations. 482 00:53:50.420 --> 00:53:54.620 And if you can't get data, you can't put it into the regression. 483 00:53:54.620 --> 00:54:01.220 And it doesn't do, of course, to use past values as an expression of expectations. 484 00:54:01.220 --> 00:54:07.220 Lipsy even showed his 1960 article that past values don't tell us much of anything. 485 00:54:07.220 --> 00:54:12.120 They're not correlated at all, really, with future values. 486 00:54:12.120 --> 00:54:24.120 And hence again, we're sort of in an econometric block here, where we simply, until other variables that can be quantified or identified and put into the equation, simply don't know what to do, we don't have anything. 487 00:54:24.120 --> 00:54:32.120 The Phillips curve simply does not exist. And of course, if you were to find all the variables and put it in there, you would probably have all the variables. 488 00:54:32.120 --> 00:54:37.120 I mean, it would be everything by the time you got finished. 489 00:54:37.120 --> 00:54:40.320 Let me just quote one more thing. 490 00:54:40.320 --> 00:54:43.020 This is from the economic report of the President, 491 00:54:43.020 --> 00:54:45.820 from the anonymous scribes who wrote that. 492 00:54:45.820 --> 00:54:49.320 In their viewpoint of the Phillips Curve, they said this, 493 00:54:49.320 --> 00:54:54.320 that recent data provide little evidence of the trade-off between inflation and unemployment. 494 00:54:54.320 --> 00:55:00.620 The recent experience in other countries also appears to contradict the notion of a stable trade-off 495 00:55:00.620 --> 00:55:03.320 between inflation and unemployment. 496 00:55:03.320 --> 00:55:16.220 So perhaps, even in the mainstream work, the tide is turning on the Phillips curve, but it certainly has never existed, let alone simply disappeared in the 70s and 80s. 497 00:55:16.220 --> 00:55:20.820 So just in summary about the Phillips curve, it doesn't exist. 498 00:55:20.820 --> 00:55:26.020 Second, it can't be derived from the theory that is provided to explain it. 499 00:55:26.020 --> 00:55:42.020 The third, the data that's used to generate estimates of the Phillips curve is highly favorable, it's aggregated and hence highly favorable to making the case of the Phillips curve and that data is inappropriate, should use raw data, not aggregated data. 500 00:55:43.020 --> 00:55:49.020 And finally, even with favorable data, estimation does not support the existence of the Phillips curve. 501 00:55:49.020 --> 00:55:56.020 R-squares of 0.64 and 0.28 are not too large. 502 00:55:58.020 --> 00:56:06.020 Now if I may turn to the multiplier and make some, I will not turn to the multiplier, I'll quit, I'll quit there. 503 00:56:06.020 --> 00:56:08.020 Thank you very much.