Wednesday, January 28, 2015

On Glasner on the Long Run Phillips Curve

David Glasner has another interesting post questioning Milton Friedman's immense status. This time he asserts that the claim that the long run Phillips curve is vertical does not have implications which are useful to policy makers or macro econometricians. I think it is best to just click the link rather than trust my effort to summarize.

I comment

I entirely agree. I think the practical and empirical irrelevance of the long run Phillips curve helps us understand how it came to be believed that old Keynesians (I am thinking Solow, Samuelson and Tobin) contested Friedman's claim. In fact, in everything by them which I have read (which isn't close to everything that that they wrote) they agreed with his argument and conclusion, then went on to say that it didn't offer much guidance to policymakers or econometricians. That is, they made your point (again and again). They are considered to be very smart, but not for making that obvious but important point again and again.

Now the fact that 4 such economists agree should convince me. But I beg to differ with all 4 (see below for qualifications). The argument relies on the assumption that there is a unique equilibrium unemployment rate. It is assumed that cyclical unemployment can't become structural or, in modern jargon, that there is no hysteresis. The existence of a natural rate of unemployment which is also the NAIRU is an article of faith. There isn't much evidence in this continent (Europe) for any such thing. Friedman's obvious and convincing claim is that forecast errors can't have the same sign indefinately. The assertion that deviations of unemployment from the natural rate are all due to forecast errors and nothing else anticipates so called new Keynesian macroeconomics and still dominates the profession. However, it was not argued or defended and has been challenged by decades of European data. Samuelson and Solow discussed this issue in their 1960 AEA talk on the Phillips curve. I'm sure Tobin discussed it a lot. But somehow hysteresis is found when economists look for it then assumed away when they advise policy makers.

The phrase "the long run Phillips curve" has content even without the possible additional words "is vertical" or "slopes down". The phrase asserts that there is no hysteresis. It asserts that forecasts for unemployment and inflation in the distant enough future must lie on a curve -- that the set of equilibria is one dimensional. With extreme enough hysteresis the set of equilibria would be limited only because the unemployment rate must be between 0 and 100%. Such a model would be crazy, but the assertion that the set equilibria is one dimensional is an assumption not a result.

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