Site Meter

Saturday, July 26, 2014

Comment on Noah Smith

Noah Smith wrote an easy to read version of his thoughts on why DSGE models aren't used by the private sector. It is, of course, an excellent article. He includes some conventional history of 1970s macrieconomic thought. I object strongly. My comment. 1) "The Keynesian SEMs predicted that when the Federal Reserve lowered interest rates, it should have given the economy a boost; instead, all it did was create useless, harmful inflation. " Definitely false. In particular around 1980 Volcker demonstrated that he had the power to make the GDP turn on a dime. The data show a huge correlation of short term interest rates and growth (with the well known roughly 6 month lag). 2) Robert Lucas,“We tried (stupid) inflation! It didn’t (dang) work!” . Did we really ? Whose idea was that ? Why are the Keynesian inflation advocates never named or and their advocacy never cited ? The simple reason is that they are straw men. 3) The SEMs could have been tweaked to fit the data. Two things. They were tweaked to give no long term inflation unemployment tradeoff. Second, the old SEMs fit the data from the 70s fine. The evidence available in 1973 and in 1980 doesn't fit the then leading new classical model at all. It fits the old Keynesian models from 1971 very well. The tweak to old Keynesian models (replacing an old 1960-70s Phllips relationship in which wage inflation depends on a few lags of price inflation and unemployment with one where the change in inflation depends on unemployment) replaced models which fit the then and now available US data with models which don't. 4) As Lucas explained in "Econometric Policy Evaluation: a Critique." his argument was not at all original having been made by the developers of SEMs while they were developing SEMs. There is no mystery why people with money on the line don't use DSGEs. It is a complete mystery how they took over academic macro (I was there not then but soon after). The candiate explanations you present in this post are not valid. The stylized facts on which they depend are falsehoods.

Friday, July 18, 2014

On Brad on 2 intellectual Fathers of Reagan and Thatcher

I am going to do Brad Fair use and cut and past this post. (do click the link anyway to be fairer to him) THURSDAY HISTORY: INTELLECTUAL ORIGINS OF REAGAN-THATCHERNOMICS The policies that enabled the creation of our Second Gilded Age were born at the end of the 1970s out of a particular reading of the political economy of that moment. Were the ideologues and the intellectuals of the right correct back when they claimed in the late 1970s that the economic problems of the 1970s were the result of "too much government" or of "an excess of democracy"? I think not. But in order to evaluate the argument we need to remember what it was. So here are the particulars of the claims that the U.S. in the late 1970s suffered from too-large a government and too-strong a democracy set forth by Martin Feldstein9 and Samuel Huntington10, with 1-17 from Feldstein and 18-31 from Huntington: [ed note Feldstein quoted -- I'm not sure about context] 1"Real GNP growth slowed from an annual rate of 3.9% between 1947 and 1967 to only 2.9% between 1967 and 1979... productivity per man-hour in... private business... 3.2% during 1947-67 to less than 1.5% since 1967 and less than 1% since 1973..." 2"The average unemployment rate rose from 4.7%... to 5.85%..." 3"The average rate of... CPI inflation jumped from 2% to 6.7%... with an acceleration to an average of nearly 9% since 1973 and over 13% in 1979..." 4"Stock prices... rose sixfold between 1949 and 1969.... In the decade since... in constant dollars fell nearly 50%..." 5"A falling share of national income devoted to net investment and to research and development..." 6"Increasing pressures and risks in the financial sector..." 7"Low profitability and an aging stock of plant and equipment in many specific industries..." 8"A deteriorating performance of United States exports..." 9"Expansionary monetary and fiscal policies... in the hope of lowering the unemployment rate but without anticipating the higher inflation rate that would eventually follow..." 10"High tax rates on investment income were enacted and the social security retirement benefits were increased without considering the subsequent impact on investment and saving..." 11"Regulations were imposed to protect health and safety without evaluating the reduction in productivity that would result or the effect of an uncertain regulatory future on long-term R&D activities..." 12"Raising the amount and duration of unemployment benefits to the current high levels to avoid hardship among the unemployed would encourage layoffs and discourage reemployment..." 13"Medicare and Medicaid... lead[ing] to an explosion in health care costs..." 14"Welfare programs... weaken family structures..." 15"Federal aid through the tax laws and through special credit programs to encourage homeownership would have such adverse effects on the cities..." 16"The high rate of unemployment, the lack of investment demand, and the low rate of personal income tax constituted an environment in the 1930s in which the side effects of social security and unemployment compensation would be relatively innocuous. Today's tight labor market, capital scarcity, and high personal tax rates imply that these programs now impede employment and capital formation..." 17"Personal and business tax laws were designed for an economy with little or no inflation. The interaction of this tax structure with the current high inflation rates causes extremely high effective tax rates on capital income, a discouragement to saving, and a distortion of investment away from plant and equipment toward housing and consumer durables..." [Now Huntington quoted. I'm again not sure about context] 18 "The democratic surge of the 1960s raised again in dramatic fashion the issue of whether the pendulum had swung too far..." 19 "The vigor of democracy in the United States in the 1960s thus contributed to a democratic distemper... the expansion of governmental activity... and the reduction of governmental authority..." 20"Across the board, the tendency was for massive increases in government expenditures to provide cash and benefits for particular groups within society rather than in expenditures designed to serve national purposes vis-a-vis the external environment..." 21"During the 1950s and early 1960s... governmental expenditures normally exceeded... revenue... but... the gap.. was not large.... In the late 1960s... after the... Welfare Shift... the overall government deficit took on new proportions... obviously one major source of the inflation which plagued the United States..." 22"The beneficiaries of governmental largesse coupled with governmental employees constitute a substantial proportion of the public. Their interests clearly run counter to those groups in the public which receive relatively little in cash benefits from the government but must contribute taxes..." 23"In the family, the university, business, public and private associations, politics, the governmental bureaucracy, and the military services, people no longer felt the same compulsion to those whom they had previously considered superior to themselves... discipline eased and difference in status became blurred..." 24"The commandments of judges and the actions of legislatures were legitimate to the extent they promoted, as they often did, egalitarian and participatory goals. 'Civil disobedience', after all... implied the moral value of law-abiding behavior depended upon what was in the laws, not on the procedural due process by which they were enacted..." 25 "The major expansion of unionism in the public sector... add[ed] still further to governmental deficits and to the inflationary spiral..." 26 "The imposition of 'hard' decisions imposing costs on any major economic group is... particularly difficult in the United States..." 27 "Domestic problems... become intractable.... The public develops expectations which it is impossible for the government to meet..." 28"Politicians... [seek] achievement which may have an immediate payoff but which they and, more importantly, their country are likely to regret... giv[ing] to dictatorships (whether communist party states or oil sheikdoms)... a major advantage..." "An 'excess of democracy'.... The effective operation of a democratic political system usually requires some measure of apathy and non-involvement on the part of some individuals and groups..." 29 "Marginal social groups, as in the case of the blacks, are now becoming full participants in the political system.... Less marginality... needs to be replaced by more self-restraint..." 30 "Democracy is more of a threat to itself in the United States than it is in either Europe or Japan where there still exist residual inheritances of traditional and aristocratic values..." My comment That is a long and interesting list. Somewhere the crime wave seems to have fallen between to stools (between 17 and 18). I think that, to be fair to both, especially Feldstein, you should number separately. Huntington's willingness to criticize democracy and praise deference to superiors is amazingly frank. I will use the word "Feldstein" to mean "Martin Feldstein as presented by Brad DeLong". OK Feldstein. On 1,2,4 and 6 subsequent evidence has been very unkind to Feldstein. Post Reagan revolution all did worse than pre. 6 (financial risks) was an amazing hostage to fortune on which he would have lost a fortune if he took his own arguments seriously. on 5 huh ?!? the ratio of nonresidential fixed capital investment to GDP was extraordinarily high in the 70s. (also it declined in the 80s) . what the hell is he talking about ? 1-8 he is playing with timing. He is ascribing the 60s boom to the old policy regime even though it followed the policy shift. He is like the supply siders who decide that Reagan policy began in 1982. 9 this assertion is simply false. The increase in inflation was certainly anticipated by all prominent paleo Keynesians (who argued for tighter fiscal policy in the 60s). What actually happened is fiscal policy was loose (at least by pre Reagan standards) as no one likes taxing and Nixon demanded loose monetary policy to stave off the McGovern juggernaut. The second claim is a paraphrase of Arthur Burns who would tend to be more expert on the thought of Arthur Burns than Feldstein was. 10)I know of no evidence that taxing investment income reduces national savings. The data since 1979 have been very very unkind to Feldstein. 11) Feldstein assumes that health has nothing to do with productivity. The data suggest that good health precedes rapid growth (in a cross section of countries). Of course the "without considering" is simply a lie. I was alive in the early 70s and read some newspapers -- possible undesirable side effects of regulation were discussed at length (in the not so high brow Newsweek). 12) he has to deal with experience rating of UI when considering the effect on layoffs. Job search can be productive if it leads to better matches. it is easy to write down models in which UI causes a Pareto improvement. 13) Medicare, Medicaid & health care costs. This is very hard to reconcile with subsequent international comparisons. US has a larger fraction private and much higher spending than other developed countries. Private insurance plus out of pocket have grown very fast. Again subsequent data have not been kind to Feldstein. 14) there is little evidence that welfare programs weaken family structures. The structures kept changing the same way after welfare reform. Of course I must admit there is little evidence for the pro generous welfare position (say Moynihan) that it is important to provide welfare to unemployed couples too. Basically even in the 25 blue states which did this, the program was irrelevant as too few couples needed it. Now there has been a decline in teen pregnancy. That was clearly due to the clean air act (see 11 -- I am 100% serioius). 15) good point Marty -- note how actual elected Republicans don't agree. 16) again wtf is the labor market loose or tight ? In 2 vs 16 Feldstein has it both ways. On taxes, the top rate was higher in the 40s and 50s than in the 60s and 70s. As quoted, Feldstein is using high GDP growth in a period with UI, Social Security and high tax rates as proof that you can't have high growth with UI, social security and high tax rates. WTF ! Huh ! etc 17) good point again. However, I again note the very high level of investment in plant and equipment in the 1970s. Summing up. I think Feldstein wrote crazy things about investment in the 70s and growth with high taxes UI and social security. I think he knew better, but was exploiting the vague sense that everything was very right wing in the 50s. I think he counted on tricking people who were paying more attention to the 18-30 issues than to actual economic policy. He arbitarily picked the peak of a boom as the end of the good old days. This is cheating. However, he certainly was right that 70s economic performance was very disappointing. I didn't think that Reaganism was worth a try, but I can see how some people did. Subsequent poor economic performance refuted Feldstein's argument, but hey, that's social science. I think this is also true of health care spending. The USA had not pulled away from the pack yet. I think claims 8-17 (which are standard pro-market arguments) have weak empirical support (that includes 15 and 17 with which I agree). I'm pretty sure they are based on economics 101 and the assumption that elasticities are high. Trying to be quicker on 18-30 which I will ascribe to Mad Dog 18. His courage amazes me. Even George Will doesn't question Democracy so bluntly any more. 19. The word "distemper" is pejorative. Think of trying to tell a tea partier that a reduction in "government authority" is "distemper" I think they would lose their tempers. Again amazing frankness (I refer to mad dog who may or may not have anything to do with a Harvard prof.) 20. WTF !!! Does mad dog think Vietnam is internal to the USA. Some of the points clearly refer to the 60s and not the late 70s. Where was prof. Mad Dog at the time ? 21 subsequent events have not been kind to mad dog either. You have a problem yourself if you consider deficit phobia to be part of the intellectual origins of Reaganism. 22. mad dog has a problem. The big expansion in spending was mostly Medicare. Not cash, and benefiting all who live past 65. He seems to think that a high fraction of GDP was spent on means tested cash benefits. He is wrong. Increased public employment had a lot to do with teaching baby boomers how to read. I'm sure he doesn't oppose that. 24) does mad dog know what "procedural due process means" ? It sure doesn't mean depriving people of the vote then passing laws to keep them separate and unequal. Did mad dog know that congress is supposed to declare war and peace and that Johnson was sure the Tonkin gulf resolution did not grant him authority to escalate ? I mean how the hell does he dare place contempt for due process on the side of protesters when it characterized those against whom they protested ? 28-29 and 30 again amazing boldness. Also cluelessness. Had Mad Dog ever visited Europe ? I knew there was somewhere the Us authoritarians frank expression of envy of dictators. I think subsequent events have taught a bit about the advantages of dictatorships. The fact is that history shows that Democracy works horribly but less horribly than the alternatives.

Tuesday, July 08, 2014


Comment on a Drum Foser Twitterdebate Drum wrote For better or worse, politicians spend a lot of time thinking about how various audiences—supporters, opponents, undecideds, pundits, members of Congress, the media—will react to their proposals, and they shape their messages accordingly. If you're reporting on politics, you have to include that as part of the story, and optics is as good a word as any to describe it. I wrote a long comment below. Here I just want to note that "you have to" is a catagorical imperitative. Drum didn't write "If you want to obtain result X, you have to" which would be a hypothetical imperative. It is very odd to find a catagorical imperative in a paragraph which begins "For better or worse." I object to "If you're reporting on politics, you have to include that as part of the story," I had the impression that, given the first amendment, reporters could chose what to report. I think you are attempting to answer a question about what people should do by considering only facts and not values. This is a harsh claim, but I think I can back it up. Your discussion of what reporters must do includes no discussion of the proper role of journalism in society, no hint of an idea of what the point of being a reporter is. I will assume that their useful role is to make the citizens better able to make informed decisions. I claim that citizens would be more able to get what they want out of government if reporters reported only on policy proposals and evidence related to forecasts of the effects of the proposed policies. The question is what should be done. You say people will not decide based on evidence and specific proposals. You respond to a proposal to light a small candle by cursing against the darkness. I think it is possible for reporters to refuse to listen to campaign operatives (no one can force them). To report as follows "the X campaign released a press release which included claims of fact unsupported by links to independent sources" full stop. No mention of the content. Or "X claimed he would achieve a desirable result but provided no details as to how he would" full stop. This can be done. It is legal (note first amendment). Foser is talking about what journalists *should* do. In the debate, it is imagined that the whole profession is waiting for your advice. The argument that one newspaper or TV channel which did this would lose market share to the unscrupulous political rumor mongers is out of order. Your rule seems to be just because something is happening, and someone wants it reported, reporters must report it. But of course this rule can't be followed given world population. It is more nearly that powerful people want it reported so it must be reported. But I think it is that people whom reporters quote (off the record) want to be quoted (off the record) so this is the way things must be. I have a question (and a tiny shred of hope for an answer). What did you mean by "have to" in "have to include that" ? Not that reporters would die if they didn't, nor that they would be sent to jail. Was this "in order to do you job the best you can, you have to" ? This is statement about right and wrong and can't be addressed without asking what the socially useful role of journalism is. Or is it, you have to to keep your job, given the fact that your editor has to keep up circulation and people like to read that stuff. That might even be a true claim, but it doesn't respond to Foser's assertions about what journalism should be, which is quite distinct of what is the best we can hope it will be given reader/viewer tastes and competitive pressures. update: dangerous chemicals can cause synesthesia "chemical interests, creates particularly noxious “optics” "

Monday, July 07, 2014

TB testing

My daughter needs a Tuberculosis test for a job. This is therefore an experiment in comparative health care system functioning Italy vs USA. Now in Italy she (OK her mother) was able to make an appointment quickly and then get a tetanus booster. Considerable waiting in the doctor's office (even with the amazing efficiency of Anna the amazing office managers who handles all bureaucracy for two MDs. Charge 0.00. This requires going to Gianfranco Rondoni the one doctor "Medico di Base" who can provide free ambulatory care or prescribe free amulatory care. He also prescribed a TB test as requested. Then in a TB testing clinic (private I think her mother took her) she was told that the TB test was unreliable because of the tetanus booster, so the refused to do it. No US MD (of three asked) has any idea what they were talking about. There is free TB testing available at the Montgomery County Department of Health and Human Services Dennis Avenue Clinic . However they do a new fancy test and the employer asked for an old style PPD test. From an abundance of caution, we went to Fast Track Urgent Care at 10540 Connecticut Ave Kensington, MD 20895 where we got a PPD in about five minutes. No line. Fast courteous care. $45.00 . During the brief wait (and the few seconds to stick the tines in). I was entertained or rather appalled by CNN health. CNN was talking about Deer Antler dietary supplements and considering the claim that they speed recovery from injury and increase "energy". I thought it was an infomercial until Dr Sanjay Gupta appeared. The sound was set to near zero to not irritate the patients (or customers ?) but I heard him say in a very polite tone to some quack that the claims are viewed with great skepticism because they seem too good to be true. i think it is here (search the page for Gupta). I had some trouble googling [health deer antlers gupta] as there was more than one relevant hit (including one to an unreadalbe xml) This was in marked contrast to the angry tone he used to claim that Sicko by Michael Moore contained factual errors in a surprise fact check before an interview. I remind my reader(s) that the only part of the fact check which alleged an error of fact was CNN's false claim about a true assertion in Sicko. Aside from that the fierce tone was used to present the other side of a debate as if the fact that a case for pro could be made implied errors in the case presented by Moore. In itself a disgraceful episode, but one which is made infinitely more shocking by the velvet glove treatment of peopel hawking dietary supplements. I recall that Barack Obama seriously considered nominating Dr Sanjay Gupta surgeon general. Now I must include a disclaimer. I saw and (barely) heard a man identified as Dr Sanjay Gupta on CNN. I can't be 100% sure it is the same Sanjay Gupta who attacked Moore and was considered a credible Surgeon General. It might be a different Dr Sanjay Gupta for the rubes. The point is that I am not sure I can judge the effect of 7 years of aging since the last time I saw video of Dr Sanjay Gupta. The Dr Sanjay Gupta I just saw looked more than 7 years older than the one who slandered Moore (reckless disregard for the truth -- not actionable because CNN conceded the point). I think I saw a prematurely aged withered hack, but I may have seen a withered hack who works for the same employer as the younger aggressive act I saw 7 years ago. I realize that this complaint will not be compreshensible to any of my few readers who are young, but we old timers remember that, long long ago, CNN was a serious news network.

Thursday, July 03, 2014

Some people read the post below through to the end.

J. Edgar Mihelic read the very incredibly boring post below to the end. Having never met the man, I assume he smells like Noah. Also "Anonymous" read the post to the end. To paraphrase Dr Strangelove Vy did you keep your name a secret ? You are not supposed to keep it a secret. The offer expires now.

Tuesday, July 01, 2014

Phillips curves with anchored expectations

update: J. Edgar Mihelic read the very incredibly boring post below to the end. Also "Anonymous" read the post to the end. To paraphrase Dr Strangelove Vy did you keep your name a secret ? You are not supposed to keep it a secret. The offer expires now. In his very famous AEA Presidential address, Milton Friedman argued that if the Fed attempted to target unemployment at 3% the result would be accelerating inflation. Then he concluded that there is a natural rate of unemployment and no long term inflation unemployment tradeoff. I will claim that the conclusion doesn't follow.

I will assume that unemployment is a function of actual inflation minus expected inflation. I will also assume that people are smart enough that no policy will cause them to make forecast errors of the same sign period after period after period.

Friedman's conclusion follows if there is the additional assumption that expected inflation is a constant plus a linear function of lagged inflation. In this case, unless the coefficients sum to one and the constant is zero, it is possible to cause a constant non zero forecast error. It can't be that people are dumb enough to stick with a constant plus a linear function with coefficients that sum to anything but one if that rule is exploited to make surprise inflation always always positive.

However, I know of no one who ever wrote that such a simple model of expectations is the truth. Rather some people including Cagan, Friedman, Tobin, and Solow asserted that something like that is a useful approximation at some times in some places. Many authors expressed belief in a more complicated story in which inflation expecttions are anchored if inflation is low and variable but not anchored if inflation is high and/or steady.

I think such expectations can be modelled either as a result of boundedly rational learning with hypothesis testing or ration Bayesian updating. I will try to do so (famous last words of this post which sensible readers will read).

The monetary authority will, in fact, stick to a simple rule (but agents do *not* know that the rule never changes). It can target inflation and is tempted to trick firms into supplying more than they would under perfect foresight by setting actual inflation higher than expected inflation. I will assume that perfect inflation forecasting causes unemployment to be 5%. This is the non accelerating inflation rate of unemployment. Unemployment is linear in the inflation expectations error so the long term average unemployment is equal to the long term average expectations error.

The simple rule may be stochastic with targets based on coins flipped and dice rolled etc in secret. The monetary authority wants low unemployment and low inflation.

The question is can the long term average unemployment rate be lower than 5%

First bounded rationality with hypothesis testing. The bounded rationality is forecasting with a simple rule which might included parameters estimated by OLS on old data of. In the very simplest rule expected inflation is 2% no matter what. The hypothesis testing part is it is assumed that forecasting rules are ordered from a firwt rule to a second etc. When agents use rule n they also test the null that rule n gives optimal forecasts against the alternative that rule n+1 gives better forecasts. The switch to rule n+1 if the null is rejected a the 5% level (as always this can be any level and as always I choose 5% because everyone does). I will assume that rules are also ordered so if rule n gives persistent underestimates of future inflation, rule n+1 gives higher forecasts.

Forecasting rule 1 is forecast inflation equals 2%. Rule 2 is forecast inflation is equal to a constant estimated by OLS. Rule 3 is forecast inflation is equal to an estimated constant plus an estimated coefficient times lagged inflation. Rule 4 is a regression on two lags of inflation. the series of rules goes on to infinity always adding more and more parameters to be estimated, and includes the actual inflation rule (the monetary policy rule for this silly model).

Friedmans story about accelerating inflation at 3% unemployment works in this model. Rule 2 is flexible enough for his example. If inflation is higher than forecast inflation by a constant, the estimated constant term in the regression grows without bound.

A key necessary assumption is that agents never accumulate more than a finite amount of data about the Monetary authority. A sensible way of putting this is that learning about the Fed Open Market Committee restarts each time a new Fed chairman is appointed. To make things not too easy for myself, I assume that once agents pass from rule 1 to rule 2 they stick with it using all data to estimate parameters. The data used to test the current rule against the next one are only those accumulated with the current chairman. I will assume Chairmen are replaced at known fixed intervals of say 100 periods of time.

Fed open market committe members know all this. They can set inflation so the 2% forecast rule is never rejected against the estimated constant. The optimal strategy will be mixed, that is they will randomize inflation so it isn't too easy to learn what the best estimated constant is. I will assume they set inflation equal to a constant plus a mean zero white noise disturbance term (to be clear the expected value of the random term conditional on lagged information is always zero)

Clearly FOMCs can achieve set inflation to be 2.000001% plus a mean 0 variance 1 constant term without getting caught before the chairman's term expires. This means that the long run average unemployment rate can be less than the NAIRU. This means that there is a long run tradeoff between average unemployment and average inflation.

update: we have a winner so the offer immediately below has expired. [if anyone has read this far, please tell me in comments and I will praise you to the sky in a new post]

Friedman's argument can be true, unemployment can depend only on expectation errors and there can be a long run inflation unemployment tradeoff. There is a big difference between trying to achieve constant unemployment lower than the NAIRU and trying to achieve average unemployment lower than the NAIRU. Friedman also implicitly assumed that the monetary authority never changes and is known to never change.

Basically his implicit assumption is either the Fed can set unemployment to any constant or there is a natural rate. This doesn't follow for many many reasons. I just described one.

OK I talked about Bayesian learning. This post is already way too long. The idea about Bayesian is we start with a prior with a huge mass at inflation is 2% plus a mean zero disturbance term. Then there are positive prior probabilities on a huge variety of other models. However all of the other models have time varying coefficients which follow random walks. This means that the forecast conditional on belief in model N depends on parameters estimated with exponentially weighted lagged data. This means that given the 2.0000001% plus noise rule, the ratio of the likelihood for those models to the likelihood with the 2% plus noise model doesn't growth without bound. This means that the posterior keeps a huge mass on 2% and there is a long run tradeoff between long run average unemployment and long run average inflation.

A comment on Kling on Remembering the 1970s

Arnold Kling agrees with Simon Wren-Lewis that the rational expectations revolution was caused by something other than evidence, and, in particular, other than the stagflation of the 1970s. Their clearly stated and valid point is that Friedman did not believe in rational expectations and had no trouble explaining and, more or less, predicting the stagflation. I agree entirely with this point.

I disagree 0.1% with Wren-Lewis (I object to his use of the word "need") and about 0.01% with Kling who suggests a claim about what was necessary without quite making it.

Now I cut and paste an over long comment with which I polluted Kling's comment thread. I do not recommend reading the same old same old. I seriously considered posting this to my hard drive (but not my trash can -- I'm a word horder).

Thanks for the link. I think that you and Wren-Lewis agree 100%.

The 0.1% is that I think Friedman's story (in which backward looking expectations were pretty explicit) is sufficient to explain stagflation in the USA in the 1970 but not necessary. I think the pre-Friedman and contra Friedman Keynesians could fit the facts too.

[this "comment" has become much too long for a comments thread. The rest is over here]

My now old tired argument is that a model in which expected inflation is a constant plus 0.5 times lagged inflation fits the 1970s US data fine, but implies a long term inflation unemployment tradeoff and does not imply acceleration.

The model is obviously not the truth and not just because all models are false by definition. We can be sure it isn't a true claim about expectations by introspection, that is a thought experiment. No one can believe that after a thousand years of exactly 10% inflation year after year, expected future inflation will be 5%. I know of no evidence that anyone ever believed any such thing (although I'm sure someone somewhere did, because tinfoil hats).

It was obvious to prominent Keynesians (I am thinking of Solow and Tobin) that the one lag autoregressive expectations model wasn't the truth. It is also obvious that in around 1970 and 1971, they thought something like it was an approximation useful to US policy makers. This view seems to me to be supported by US aggregate data through 1980 (and through 2014). I think that Friedman's position is that Keynesians should not be allowed to use friedman's methodology of positive economics and their claim that an equation was useful there and then must be interpreted as a claim that it is a universal truth. If that was his view, he was much more generoust to Solow Samuelson and Tobin than well to get personal I ever was in the 20th century (and at least the first 10 years of the 21st). I believed that they believed in a Phillips curve with no expectations term at all. I was clearly totally wrong.

As I note from time to time to time to time, it was standard to include price inflation in estimates of the Phillips relation from say Phillips's second paper on the topic on. There was a debate which can be translated into contemporary econospeak as "in around 1970, Solow believed that US inflation expectations (unlike Latin American inflation expectations) were anchored."

This doesn't mean that he predicted that they would remain anchored. Like Keynes, he clearly and definitely said that the relationship between inflation and real variables was not stable and that they decoupled given high inflation.

Solow's position was very explicitly that inflation expectations are sometimes anchored and sometimes not. So high or steady inflation is eventually reflected one for one in expectations, but low and variable inflation isn't (so the average forecast error can increase in the average inflation rate). I think that this is very devinitely the view currently expressed by, among others, Ben Bernanke, Janet Yellen and Narayana Kocherlakota. I also think it is consistent with the evidence. In any case, it is the current view of many top status economists, who remember the 1970s as we do, and is the standard view among monetary policy makers.

For example, I just noticed this

In this Economic Letter, we focus on two simple extensions that are potentially important to the current inflation outlook.

The first extension incorporates anchored inflation expectations with the constraint that long-run inflation eventually returns to the Fed’s inflation target of 2% (see Williams 2006, Stock and Watson 2010, and Cogley, Primiceri, and Sargent 2010).

note especially "Cogley, Timothy, Giorgio E. Primiceri, and Thomas J. Sargent. 2010. “Inflation-Gap Persistence in the U.S.” American Economic Journal: Macroeconomics 2(1), pp. 43–69 (which I haven't read).

The semi new point I would like to make here is that Solow's position is entirely consistent with the argument Friedmans AEA presidential address. Friedman discussed only the case of a FOMC which set a very low unemployment target (3% IIRC). If one accepts his assertion that this would lead to accelerating inflation (as I do) nothing much follows. It doesn't follow that the Fed can't stabilize. It doesn't follow that the Fed can't cause long term average unemployment to be lower or higher (within limits).

It is an example which makes it clear that belief in an expectations unaugmented Phillips curve is unreasonable. Almost nobody ever believed in an expectations unaugmented Phillips curve. Samuelson and Solow definitely did not. Hicks made an argument almost identical to Friedman's in 1967.

I think the key event was the spread of the strange belief that Samuelson, Solow et al believed in an expectations unaugmented Phillips curve. It was believed by, well for example, Robert Waldmann that looking at the data they saw a pattern and just decided to assume it was a structural relationship. I think that this strange delusion (about what Samuelson and Solow thought) was extremely influential exactly because they were famously brilliant economists. Also they and especially Samuelson were top figures in the formalization of economic theory, so a perceived error by Samuelson due to insufficient respect for theory was shocking. The take home lesson was that you better not trust data without formal theory -- that looking at data and thinking in English could lead very smart people to think very stupid things.

I don't know exactly when or how the strange delusion about old Keynsians began. It is certainly expressed in Friedman's Nobel lecture (in which he doesn't name his straw Keynesians).

Tnis all means I agree with Krugman about the role of Friedman Phelps and stagflation in causing the rational expectations revolution. However I also think that incorrect beliefs about what people who disagreed with Friedman said were crucial too.