Choosing The Right Curves

The background for inflation hysteria was pretty simple. Globally synchronized growth meant acceleration in the US economy which would raise demand for labor. The unemployment rate, faulty as it has been, suggests that any further increase in labor utilization would just have to pressure wages – the competition for workers rises as the marginal supply of them dwindles further downward (slack). Rising wages would mean rising pay and then consumer prices, therefore a more aggressive Federal Reserve that blows up the bond market.

Hysteria.

In the middle of all that is the Phillips Curve. Plotted as a simple relationship between the unemployment rate and consumer price inflation, it endures because there is just that sort of intuitive relationship in any economy. Its more extreme forms, such as the idea of an exploitable Phillips Curve, first raised by Keynesian economists Paul Samuelson and Robert Solow in 1960, has been thoroughly discredited. You can’t, as they presumed, “buy” a lower unemployment rate through tolerating or even trying to stoke a little more inflation.

That’s not what those economists were really after, of course. Paul Samuelson had written a book in 1947 which was the basis for pretty much everything that has followed since. Economists since before the industrial age have obsessed over finding the mathematical rules behind every economic process, therefore economy. Given the right equations, they believe, a whole economic system may be precisely mapped and then governed to its optimal solution sets (determined, of course, by the economists).

Foundations of Economic Analysis was meant to be a break from classical theory, as Samuelson wrote in its introduction:

The laborious literary working-over of essentially simple mathematical concepts such as is characteristic of much of modern economic theory is not only unrewarding from the standpoint of advancing the science, but involves as well mental gymnastics of a particularly depraved type.

Failure in science is a good thing, a process by which we learn about the real world as it is. In the laboratory, the downside is merely time and material, the necessary minor inconveniences to progress. In economics, it’s become a whole other story.

Translated into 21st century econometrics, it means that no matter what happens to an economy from intended policy inputs (primarily of the monetary policy variety) the equations never fail. In a real science, failure causes re-evaluation and the search for alternate theories and eventually the right answer. In Economics, there is always, always tomorrow.