Archive for the Category Never Reason From a Price Change


Is an NGDP Phillips Curve somehow “wrong”?

I touched on this issue over at Econlog, but I’ll try again here in slightly a different way.

The original Phillips Curve from 1958 had nominal wage inflation on the vertical axis.  (Actually the original original PC was developed by Irving Fisher in the 1920s, and used price inflation.) Then American economists switched to price inflation in the 1960s.  In the 1970s and 1980s, economists accepted the Natural Rate Hypothesis and the expectations-augmented Phillips Curve was developed:

When inflation is higher than expected you are in a boom, and when it’s lower than expected you are in a recession.

But inflation probably not the right variable, for standard “never reason from a price level change” reasons.  Higher inflation can reflect more AD, or less AS:

So what is the right variable?  As far as I can tell, the Phillips Curve should be using unexpected changes in NGDP:

So here’s my question to economics instructors.  Suppose you have an advanced topics chapter at the end of macro 101, which covers the standard Phillips Curve (using inflation), and discusses the Natural Rate Hypothesis and the importance of expectations.  Would it be acceptable to have a section at the very end of that chapter with the final two graphs shown here?  I.e., the two AS/AD graphs to show students the downside of using inflation as an indicator of whether the economy is overheating, and the NGDP version of the Phillips Curve to explain to students why more and more economists favor NGDP targeting.

Or is there something I am missing, which makes NGDP unsuitable for the vertical axis of a Phillips Curve?

PS.  The principles textbook I’m working on will be ready for consideration later this year, available for use in classes in the fall of 2019.


Abe reasons from a price change

Here’s the FT:

Shinzo Abe has demanded Japanese companies lift pay by three per cent next year as he uses his big victory in last week’s election to intensify his push to boost the country’s economy.

The Japanese prime minister’s decision to give a specific number marks a deepening of government interference in private sector wage settlements. Last year, Mr Abe simply called for pay rises at least as great as the year before.

Would higher wages be good for the Japanese economy?  It depends.  If the higher wages are achieved through more aggregate demand, then they might be associated with higher employment.  If implemented via less aggregate supply (as Abe proposes), they will lower employment.

Consider the following two options:

If the BOJ adopts an expansionary monetary policy, boosting NGDP, then the demand for labor will increase.  This will boost growth, increase wages, and employment will rise to point B.

If the BOJ does not boost NGDP but Abe pressures firms into raises wages anyway, then employment will decline to point C.

It’s very demoralizing that top officials in Japan the US and Europe continue to make the EC101 error of reasoning from a price change.  Over and over again.

Why do we even bother teaching EC101 in colleges?  What’s the point?

PS.  Now that taxes are in the news let me agree with Jeff Flake, who is calling for tax reform, not tax cuts.

Tax reform would be one of the very best things the GOP could do right now.  Tax cuts would be among the very worst moves they could make.

It’s often said that the modern GOP exists for one purpose only, to enact tax cuts.  I don’t think people have fully internalized the implication of that truth.  If and when the GOP does enact tax cuts and/or reform, it will no longer have a reason to exist.  Tax reform might end up being a major achievement, or it might not.  But either way the enactment of a major tax bill will mark the end of the modern GOP.  They will no longer have a reason to exist.

I have no idea what will take it’s place.  Perhaps a white nationalist Bannonite party.  National socialists.  But whatever it is, it won’t be the modern GOP—which will be dead.

PPS.  On the graph, I forget to label points B and C as a 3% wage gain.

Is the battle against “reasoning from a price change” unwinnable?

Over at Econlog, I have another post that touches on reasoning from a price change.  I must have already done a hundred such posts.  And yet every day I see more examples of this EC101 error in reasoning almost everywhere I look.  Not just among the uneducated, but in elite newspapers like the WSJ, NYT, Economist, etc. Here’s a new example from the FT:

Loose monetary policy led to share buybacks that enriched mainly the wealthy

One of the great ironies of the 10 years following the financial crisis is the way in which low interest rate monetary policy — which was designed to get Main Street USA back up and running and to help people buy homes and start businesses — has bolstered share prices and the markets more than it has helped ordinary Americans.

This is just embarrassing, and yet it happens all the time.  Is there any way to make people see that this is flat out wrong?  We teach students in EC101 not to reason from a price change, but people don’t seem to get the message.  What are we doing wrong?  Is there any way to explain this that I haven’t yet tried?  Lots of you commenters are closer to people with “average opinion” than I am.  Some of you may have recently learned not to reason from a price change.  So what works? What allows people to see that low interest rates are not a loose monetary policy?

PS.  A few reporters such as Caroline Baum warn against the fallacy of reasoning from a price change, but most don’t seem to get it.

The internet’s highest honor

Vaidas Urba pointed me to a very clever post by John Carney of CNBC.  It includes parodies of many well known bloggers, on the theme of Christmas and economics.  Here’s an example–see if you can guess who:

If the Fed would simply announce a nominal target for presents, we’d all receive more presents on Christmas day.  There are many ways to do NCPT, but I prefer that the Fed creates a presents futures market.

A lot of people look at the amount of presents under the tree and attempt to derive the stance of Santa.  But this is wrong.  You need to examine the demand for presents as well as the supply.  In general, a large pile of presents is a sign that Christmas policy has been too tight, while coal in the stocking is a sign that it has been too loose.

At the risk of spoiling the joke, I’m going to try to improve it further

A lot of people look at the amount of presents under the tree and attempt to derive the stance the parents’ generosity.  But this is wrong.   The pile of presents represents the interaction of generosity and deserts.  In general, a larger pile of presents is a sign that the stance of Christmas policy has been relatively generous.  But the level of generosity also depends on how many presents are deserved, which depends both on the behavior of the child and the wealth of the parents.  An increased pile might represent greater generosity, but also greater deserts, due to improved wealth and/or better behavior by the child.

Yeah, I know, I’ve ruined the joke.

PS.  Although I am now a “somebody”, I am under no illusion that I am anywhere but at the bottom of the class of people called “somebody”.  But at least I’m not a nobody.

Is price flexibility stabilizing?

Rajat directed me to a post by Miles Kimball, entitled “Pro Gauti Eggertsson”. Over at Econlog I discussed one paragraph from his post.  Here I’ll discuss another:

Gauti has also taken a lead in applying the same principles he applied to the Great Depression to the Great Recession. A hallmark of his papers is very careful discussion of how they relate to key controversies in the academic literature, and indeed, they go to the heart of some of the biggest issues in the study of business cycles and stabilization policy. Price flexibility and advance anticipation of inflation are often said to be the keys to monetary policy having no real effect on the economy. But along with Saroj Bhattarai and Raphael Schoenle, Gauti argues in “Is Increased Price Flexibility Stabilizing? Redux” that, short of perfect price flexibility, greater price flexibility is likely to be destabilizing. This idea has a long history, but had not been fully addressed within the context of Dynamic New Keynesian models without investment. Along with Marc Giannoni, Gauti argues in “The Inflation Output Trade-Off Revisited” that contrary to the idea that anticipated inflation does not matter, it can matter greatly when raising expected inflation loosens the zero lower bound. The argument is made in a very elegant and clear way.

In my view, higher expected inflation is  not expansionary, holding NGDP expectations constant.  Thus if NGDP is expected to grow at 5%, then higher inflation is associated with lower real GDP growth.  The proponents of the alternative view would claim that I’m missing the point, that higher inflation expectations will cause higher NGDP growth expectations.  I don’t think that’s right. A more expansionary monetary policy may cause both inflation and NGDP growth expectations to rise.  On the other hand, supply shocks can affect inflation expectations without impacting NGDP expectations. Never reason from a price level change—always reason from a NGDP growth change.

In 1929-32, President Hoover discouraged companies from cutting wages.  This made the Great Contraction of 1929-32 even worse than it otherwise would have been.  In contrast, wages were cut sharply during the severe deflation of 1920-21. Some free market purists make too much of this comparison, suggesting that tight money is not a problem if the government allows wages to be flexible.  Not true, the 1921 depression was quite deep.

But also pretty short.  And one reason it was so short is that in 1921 and 1922, wages adjusted quickly to the lower price level.  If Hoover (and FDR) had allowed wages to adjust in the 1930s, the Great Depression would have been much shorter.

Stable NGDP growth and non-intervention in wages and prices, these policies work together like a hand and glove.

PS.  I encourage people to read Giles Wilkes’s new piece on blogging.  Wilkes was nice enough to include me in with a group of much more deserving bloggers.  I was also pleased to see him talk about Steve Waldman, a wonderful blogger and also a good example of how the blogosphere is a meritocracy, where professional credentials do not matter.

PPS.  Trump?  Still  . . . an . . . idiot.

HT:  Tyler Cowen, Tom Brown