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Sunday, May 20, 2012

Did Samuelson and Solow Really Claim that the Phillips Curve was a Structural Relationship?

Like Robert Waldmann, I have always taught that the Phillips curve was initially promoted as a permanent tradeoff between inflation and unemployment. It was thought to be a menu of choices that allowed most any unemployment rate to be achieved so long as we were willing to accept the required inflation rate (a look at scatterplots from the UK and the US made it appear that the relationship was stable).

However, the story goes, Milton Friedman argued this was incorrect in his 1968 presidential address to the AEA. Estimates of the Phillips curve that produced stable looking relationships were based upon data from time periods when inflation expectations were stable and unchanging. Friedman warned that if policymakers tried to exploit this relationship and inflation expectations changed, the Phillips curve would shift in a way that would give policymakers the inflation they were after, but the unemployment rate would be unchanged. There would be costs (higher inflation), but not benefits (lower unemployment). When subsequent data appeared to validate Friedman's prediction, the New Classical, rational expectations, microfoundations view of the world began to gain credibility over the old Keynesian model (though the Keynesians eventually emerged with a New Keynesian model that has microfoundations, rational expectations, etc., and overcomes some of the problems with the New Classical model).

Robert Waldmann argues that the premise of this story -- that Samuelson and Solow thought the Phillips curve represented a permanent, exploitable tradeoff between inflation and unemployment -- is wrong:

The Short and Long-Run Phillips Curves: Did Samuelson and Solow claim that the Phillips Curve was a structural relationship showing a permanent tradeoff between inflation and unemployment? James Forder says no.

Paul Krugman, John Quiggin and others (including me) have argued that the one success of the critics of old Keynesian economics is the prediction that high inflation would become persistent and lead to stagflation. The old Keynesian error was to assume that the reduced form Phillips curve was a structural equation -- an economic law not a coincidence.

Quiggin and many others including me have noted that Keynes did not make this old Keynesian error... The old Keynesian error, if it occurred, was made later. I have claimed (in a lecture to surprised students) that it was made by Samuelson and Solow. Was it ?

This is an important question in the history of economic thought, because the alleged error serves as a demonstration of the necessity of basing macroeconomics on microeconomic foundations. For a decade or two (roughly 1980 through roughly 1990 something) it was widely accepted that, to avoid such errors, macroeconomists had to assume that agents have rational expectations even though we don't.

The pattern of a gross error by two economists with impressive track records and an important success based on an approach which has had difficultly forecasting or even dealing with real events ever since made me suspect that the actual claims of Samuelson and Solow have been distorted by their critics. To be frank. this guess is also based on a strong sense that the approach of Friedman and Lucas to rhetoric and debate is more brilliant than fair.

I am very lazy, so I have been planning to Google some for months. I finally did. ... I googled samuelson solow phillips curve

The third hit is the 2010 paper by Forder which discusses Samuelson and Solow (1960) (which I have never read). ... Forder quotes p 189
'What is most interesting is the strong suggestion that the relation, such as it is, has shifted upward slightly but noticeably in the forties and fifties'
So in the paper which allegedly claimed that the Phillips curve is stable, Solow and Samuelson said it had shifted up. Rather sooner than Friedman and Phelps no ?

So how has it become an accepted fact that Samuelson and Solow said the Phillips curve was stable ? This fact is held to be vitally centrally important to the debate about macroeconomic methodology and it is obviously not a fact at all. How can it be that a claim about what was written in one short clear paper is so central to the debate and that no one checks it ?

They did caption a figure with a Phillips curve "a menu of policy choices" but (OK this is a paraphrase not a quote)
After this they emphasized – again – that these 'guesses' related only to the 'next few years', and suggested that a low-demand policy might either improve the tradeoff by affecting expectations, or worsen it by generating greater structural unemployment. Then, considering the even longer run, they suggest that a low-demand policy might improve the efficiency of allocation and thereby speed growth, or, rather more graphically, that the result might be that it 'produced class warfare and social conflict and depress the level of research and technical progress' with the result that the rate of growth would fall.
So, finally after months of procrastinating, I spent a few minutes (at home without access to JStor) checking the claim that is central to the debate on macroeconomic methodology and found a very convincing argument that it is nonsense.

If that were possible, this experience would lower my opinion of macroeconomists (as always Robert Waldmann explicitly included).

    Posted by on Sunday, May 20, 2012 at 11:06 AM in Economics, Macroeconomics, Methodology | Permalink  Comments (49)


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