Archive for January, 2008

Phillip’s Curve

Thursday, January 31st, 2008

Keynes’ contributions to monetary theory were combined with the work of his predecessors to make a working synthesis.  For a given supply of money, there is an equilibrium path of the price level.  The equilibrium price in the current period, given next period’s price level, is just high enough to reduce the real value of this period’s cash balances down to the quantity demanded.  This is figured at the corresponding rate of interest and output level.  If people expect that the general level of prices and nominal wages is higher, and we assume the actual price level equals this expected level, the result will be disappointment. 

            Keynes noticed that the wage rate would not take the jumps sometimes necessary to maintain equilibrium and so the need for a more general theory with the wage off the equilibrium track was needed.  It was decided that the wage would move gradually move towards the new equilibrium path but the mismatch would lead to a bulge of unemployment.  Likewise if the new path was higher, there would be a drop off in unemployment.  They thought this could be curbed with inflation but they learned that over time higher doses would be needed to overcome expectations. 

            From this came an article by A.W. Phillips in the academic journal Economica in 1957.  Phillip’s used ordinary and quantitative terms which were much more accessible to all.  The rate at which the nominal wage level is changing is a decreasing function of the level of the unemployment rate.  Further, the rate of unemployment required to hold down the rate of wage inflation to the level of normal experience- the average, and accustomed, rate- is certainly positive, perhaps 2 to 3 percent in the UK.  He also discovered that among years with the same level of unemployment rate there tended to be a higher rate of wage inflation when the annual unemployment rate was falling than when the unemployment rate was rising.  It seemed to say that if there was an aggregate excess supply then nominal wages would be found falling and employment would be depressed.  This would be as long as wages remained too high to eliminate the excess supply and both the effects of the excess supply would be larger the greater was the size of excess supply.  That is to say that with the sudden appearance of an excess supply that is maintained at a given level for a while would first generate a positive rate of change of unemployment alongside falling wages and only later, a higher level of unemployment rate without a positive rate of change.  This part of the Phillip’s curve seemed intuitive to most. 

            Some problems did lay hidden among these theories. Among them was the question of why nominal wages did not jump down to their new equilibrium level and the problem of determining the pace at which wages fell.  More problems came about when they had to explain how the Phillip’s curve was sloping and its rightward position.  Money wage rates tended to be rising over a range of positive unemployment rates, including rates exceeding the lower bound obtainable by high-pressure aggregate demand levels.  Yet more trouble came along when they had to make sense out of the older Continental doctrine.   Below normal unemployment constantly fuelled by a permissive monetary-fiscal policy will soon cause wages and prices to hyper-inflate until collapse or structural change takes place.

            In the 1960s, a revelation took place: The higher unemployment level comes about because “expected wages” in the economy as a whole exceed “actual wages,” and as information comes in that actual wages elsewhere are lower than expected the ensuing downward revision of expectations will induce workers to accept still lower actual wages.  The news of the initial fall of wages is enough for workers to expect that the general wage level will now fall to exactly the job-preserving level, so that the unemployment rate will return to the equilibrium level; otherwise workers are implied to be repeatedly misforecasting the wage level, contrary to rational expectations.  This also shows high unemployment preceding a large wage fall. 

            Another problem came with explaining the coexistence of rising nominal wages with above-minimum unemployment.  If the unemployment rate were driven to zero, quitting would be presumably rampant and so the firm would pay a wage premium.  Wages do not rise only when firms want to be more competitive than others.  Wages may also rise because the firms believe they must raise their wages just to avoid losing competitiveness.  Therefore, nominal wages may not be rising due to labor market disequilibrium, but rather the prospect of productivity growth.  Maintaining a steady unemployment rate below that constant equilibrium rate would entail rising inflation without bound. 

            This was another good article when it comes to getting an overview of a topic.  It did a good job of describing how the Phillip’s curve works and some of the problems it faces.  I think it was kind of dense at parts and I did not understand all of it, but overall it was pretty good.

 

“Phillips Curve,” New Palgrave Encyclopedia of Economics, pp. 858-860   

Posted in e488-phillipscurve | No Comments »

Keynes

Thursday, January 31st, 2008

John Maynard Keynes changed the way that economics was looked at by analyzing markets on two different levels.  He was the first to look at actions by individuals as something completely different than the overall market movements.  The Classical economists looked at reductionism in which the macro economy was merely an aggregate of firms at the micro level.  The obvious connections between individual choices and the overall economy means they cannot be completely separate however, Keynes understood that the economy at the macro level was not merely the sum of all of the firms on the micro level.  There are three main areas of Keynesian thought which will be discussed: Fundamentalist Keynesianism, Hydraulic Keynesianism, and Reconstituted Reductionism. 

            Fundamental Keynesians saw Keynes’ ideas as an outward assault on reductionism in general.  For fundamental Keynesian’s, their ideas are summed up in his article, “The General Theory of Employment,” which was published in the Quarterly Journal of Economics of 1937.  The main points of the “General Theory” are said to be the chapters titled “The State of Long-Term Expectations,” and “The Essential Properties of Interest and Money.”   One argument of the fundamentalists was that Keynes’ theory of liquidity preference would have devastating effects on the reductionist theory if it were allowed to be applied to all assets.  One fundamentalist, Shackle, has focused his work on the creative element in human choice.  The paper in the QJE is most notably an attack on the type of choice making that the reductionist theory rests upon.  Keynes emphasizes that the basis of choice lies in vague, shifting, and uncertain expectations of future events and conditions.  He also illustrates how coordination of crowd behavior is unique because many members of the group take their cues from one another.  He also points out that market equilibrium is not connected to individuals’ intentions in the aggregate.  Fundamentalists look at equilibriums not so much as a simplification but a distraction.   One of the main points of Keynes’ thought is freedom from equilibrium theorizing.  Fundamentalist Keynesianism is “concerned with the texture rather than the direction, as it were, of the economic process.”  Fundamentalists agree that reductionist thought is flawed however, they are not nearly as certain as what the correct way of thinking is.  To summarize Keynes’ theory of employment: “unemployment in a market economy is the result of ignorance too great to be borne.”

            Hydraulic Keynesianism shows a time period where people were spreading Keynes’ ideas with great enthusiasm.  The post-war period marked the beginning of the excitement of the diffusion of Keynes’ ideas.  This is where Keynes’ ideas came into play with macroeconomic policy with the government using the budget to regulate the economy.  It is noticed that Keynesianism as a policy doctrine and Keynesianism as an academic theory have moved in opposite directions.  Hydraulic Keynesianism is the belief that stable relationships do exist at the aggregate level between overall flows.  Without a belief in the connection between these flows, there would be no economic theory but merely national income accounting.  Hydraulic Keynesianism and reductionism are alternative programs for theorizing as opposed to alternative theories and so ideas from both can be present in the other.  They do not bother with what can or cannot play a role in the theory, but more importantly, what is central to the theory.  In Hydraulic Keynesianism, there is only one agency making deliberate acts of choice and that agency is the government.  The belief that stable relationships between the overall flows in the economy exist lead the government to aim its policy goals and regulate economic activity and the employment level.  The stability of the relationships between these flows give the government the leverage it needs to influence the flows that it cannot directly control.  It is seen as a large step forward in the responsibility of the government now that it must consider how what it does influences things like unemployment and recession.  The hydraulic approach shows how things would work when market prices, and wages, will not perform to their allocative role.  The thing that needs to be known is under what conditions the economy may be conceived in hydraulic terms. 

            Reconstituted reductionism refers to the new framework with which people look at economic issues.  This section tries to iron out the differences between Clower and Leijonhufvud.  It is very difficult for me to understand.  I feel like it basically says that once people start looking at disequilibrium trading, Keynesian ideas can be more fully explored.  Clower discusses the “dual-decision hypothesis” and how Keynes at least had it in mind at the time when he was writing his General Theory.  Leijonhufvud focuses on the income-expenditure theory and providing a fresh perspective with which to reconsider it.  The idea is that they were attempting to establish a framework that would lend itself to Keynesian ideas. 

            Overall I think this was a very difficult read.  It is definitely informative if you can understand what they are talking about.  This does a very good job of illustrating some of Keynes’ main points and how his writings were received and how they were thought to be applied. 

Coddington, Alan. 1976.  Keynesian economics: The search for first principles.  Journal of Economic Literature 14 (December): 1258-73.  (This can be found in Snowdon’s Macroeconomic Reader.)

Posted in e488-keynes | No Comments »

Pigou

Wednesday, January 16th, 2008

Pigou Summary

            Arthur Pigou began teaching in 1901 and his main areas of interest at that time were the history of the labor movement, tariff reform, and “advanced economic theory,” or Marshallian economics, after his predecessor Alfred Marshall.  Pigou took over as professor of Political Economy in 1908 at the University of Cambridge and held the chair for 35 years.  He continued to adhere to Marshall’s ideas of economics and it is said that he never did anything to change the foundations, he merely added to the superstructure of what Marshall had taught.  He wrote several works including “The Principles and Methods of Industrial Peace,” which had to do with labor and wage bargaining, “The Riddle of the Tariff,” which was a politically controversial work about tariff reform, and “The Economics of Welfare,” which was primarily focused on labor economics. 

            Pigou’s next major subject was unemployment.  “The Theory of Unemployment,” tackled the ideas of minimum wage laws and trade union intransigence.  In this work he set out what is now known as the classical marginal productivity theory.  It was attack by Keynes who cited it as “a study of what determines changes in the volume of employment, assuming that there is no voluntary unemployment.”  Pigou reconsidered his position and published “Employment and Equilibrium,” in 1941 and later admitted that short run equilibrium with a high level of unemployment was a possibility, and that classical theory had not foreseen it.  The problem that he faced was that as wages were cut to alleviate unemployment, demand fell.  Pigou chose to defend his position by asserting that lower wages lead to lower prices which increase the real value of cash. 

            Pigou also did considerable work on the Economics of Welfare.  He drew a line between goodness and satisfaction by saying that certain desires could be brought into relation with the standard measure of money and that the satisfaction of these desires are what economic welfare is aimed at measuring and achieving.  However, he made it clear that economists were not trying to concern themselves with the whole of welfare, but with utility.  The law of diminishing marginal utility was established and he found that since the representative members of two groups, such as rich and poor, could be compared, that the transfer of income from the rich to the poor would increase total utility.  Desires became market demands that brought marginal utilities and into balance with prices.  He then saw that the national dividend, valued at market prices, could be used as a measure of economic welfare.  From this he gathered that the more equally a given dividend was distributed, the greater the overall welfare of a society would be.  He knew that getting the national dividend to a maximum would involve setting marginal costs and marginal benefits equal to one another, and that in order to do this some interference from the state might be necessary.  The government needed to step in to look out for social costs which an individual would ignore by imposing taxes and regulating monopolies. 

            It is said that Pigou did not really cause any sort of revolution in thinking about economic welfare, he merely started people thinking about it in a systematic way.  I thought the article was decent but it discussed a lot of his personal life and his hobbies as well as his contributions to economics which some of which I felt was pretty irrelevant.  It was definitely a good overview for anyone who knows little to nothing about Pigou and need a quick way to figure out what kind of work he did and how he helped to shape welfare economics.   As far as classical economics are concerned Pigou helped to develop the law of diminishing marginal returns and also laid out most of the original framework for classical unemployment theory.  Another major idea that Pigou shed light on was the utility theory.  He set out a systematic framework that other economists began to use to examine and apply classical economic theory.   

Graaf, “Pigou,” New Palgrave Encyclopedia of Economics, pp. 876-878

Posted in e488-classical | 4 Comments »

first post

Wednesday, January 16th, 2008

my first post

Posted in e488-classical | No Comments »