There are several versions of these slides:

• Handouts. html / pdf

• Slides. html / pdf

Before you read these, here’s some undergraduate material relating to the topic covered in this lecture:

• Handouts. html / pdf

• Slides. html / pdf

• Main tenet of central banks’ thinking.

• Even in the day to day language: “deflationary episode”. In fact, in previous times (unlike now), the most important symptom of a recession was a fall in prices. Samuelson and Solow transformed that into a relationship called the “Phillips curve”, also based on Phillips (1958).

• Important in Undergraduate teaching, too. Mankiw’s tenth principle of economics, in his Principles book:

• History of the Phillips curve: Phillips (1958), Leeper (1960), Samuelson and Solow (1960). Samuelson’s Economics textbook, etc.

• Importance of the Phillips curve.

• Old debates about the Phillips curve: neoclassical attack (Lucas, Sargent, Phelps, Friedman)

• Contemporary debates about the Phillips curve: Uhlig 2010, Hall 2011.

Core

Headline

Core

• After the war, there was chaos: Keynes had been proved right by the experience of World War II, which had shown aggregate demand does matter.

• So Samuelson and Solow wanted to put a limit to Keynesianism, and choose some type of “middle ground”.

• They found the Phillips curve, which according to them represented a trade-off between inflation and unemployment.

• Neoclassical Synthesis: Since Paul Samuelson and Robert Solow, the long-run is assumed to be the domain of neoclassical forces, while only the short-run is Keynesian (because of sticky prices).

• Neoclassical synthesis defined by Paul Samuelson in the 3rd edition of his Economics textbook (1955, p. 212): “In recent years 90 percent of American economists have stopped being ‘Keynesian economists’ or ‘anti-Keynesian economists’. Instead they have worked towards a synthesis of whatever is valuable in older economics and in modern theories of income determination. The result might be called neo-classical synthesis and is accepted in its broad outlines by all but about 5 per cent of extreme left wing and right wing writers.”

• Recently, the Phillips Curve has not been working at all in the U.S.: missing inflation in 2013-2019, missing deflation in 2007-2010, missing inflation in the late 1990s, stagflation in the 1970s, contrasting with always strong regional Phillips Curves.

• In Geerolf (2018), I argue that the Phillips curve exists under fixed exchange rates, not under flexible exchange rates.

• I argue that the robust relationship is between unemployment and Real Exchange Rate growth (equivalently the relative inflation of non-tradable prices). This implies the Phillips curve in fixed exchange rate regime (as the price of tradables is fixed).

• I reinterpret the post 1971 “stagflation”, and post 1933 “missing deflation” not as a change in inflation expectations, but as a switch from fixed to flexible exchange rate regimes. Alternative to the story which is usually told in textbooks of “theory ahead of facts” with Friedman and Phelps anticipating a change in inflation expectations.

• In 1971, the U.S. switched from fixed to flexible exchange rates, from having a Phillips curve to having no Phillips curve.

• “The final blow to Keynesianism was stagflation: the combination of rising inflation and unemployment, which emerged in the early nineteen-seventies.”

• “The failure to solve the ongoing problem of stagflation was the most important nail in the coffin of Keynesianism”.

• Something very important that also changed in 1971 was the exchange rate regime.

• Also in 1933.

• So probably, the reason why there was inflation during booms under Bretton Woods was that with a boom, there was a real exchange rate appreciation. Had the dollar been able to appreciate, then we would have had a “missing inflation” problem, just like the one we have today.

• As a consequence, to me, the real trade-off (which Keynes was very well aware of, actually) is between “competitiveness” and growth: that is, the problem is that when you stimulate you tend to have a trade deficits.

• So the trade-off isn’t between unemployment and inflation but between unemployment and trade deficits.

• I think this describes quite well the dilemma currently facing the U.S. economy.

• Not a Keynesian idea.

• Yet perhaps a better approach than sticky prices.

“In those days (unlike now) the leading symptom of a recession was a fall in prices.”

• This crisis has gone longer than the stagflation of the 1970s.

• It is worse. The human cost has been worse. Not a whole lot has changed.

• The fact that Keynesian economics was interpreted as resulting from sticky prices is important because it has led to attacks by freshwater economists.

• One of the most well-known attack was a paper by Lucas and Sargent titled “After Keynesian Macroeconomics”.

• In my view, Keynesian economics should perhaps never have been based on the Phillips curve, and so stagflation was not a particularly important “blow” to Keynesian economics.

• Summers, Lawrence H. “Should Keynesian Economics Dispense with the Phillips Curve?” In Issues in Contemporary Economics, 3–20. International Economic Association Series. Palgrave Macmillan, London, 1991. pdf

• Very insightful paper that Larry Summers wrote before he left academia for the policy world.

• Harsh criticism of New-Keynesian economics for not being sufficiently grounded in empirics.

• Many very good arguments: “While words like menu costs, and overlapping contracts are often heard, little if any empirical work has demonstrated any connection between the extent of these problems and the pattern of cyclical fluctuations.”

• Even its friends must acknowledge that the textbook Keynesian view of aggregate supply possesses many of the attributes that Thomas Kuhn has ascribed to dying scientific paradigms.

• Prominent Keynesians’ evaluations of the state of the field are destructive - being primarily comprised of attacks on the doctrines of the New Classical or monetarist schools.

• Keynesian economics should aspire to more than Churchill’s defence of democracy as the best of bad alternatives.

• Frequent ad hoc adjustments to account for embarrassing realities were a hallmark of Ptolemaic astronomy. It is sad but true that the half-life of various Keynesian views about the aggregate supply curve has been little more than a decade.

x

• “It was a political disaster because the stagflation episode allowed not only the Phillips Curve trade-off itself to be discredited but also Keynesianism itself”

• “This was unjust and ilogical, for no one who understood either Keynes or The General Theory - or the world and how it works - could have been surprised at the emergence of stagflation.

• It’s hard to do macroeconomics nowadays without having the Phillips curve back in your mind. It’s just not done. If it’s done it’s considered crazy or something.

• Very hard to say “the emperor has no clothes”, because you all believe it has.

• Everyone of us sees stuff in that picture.

• There was a Phillips curve. Then the trade-off was exploited. Then there was stagflation.

• It’s also very hard to see sticky prices.

• Really hard to say “the emperor has no clothes”.

Sleeman, A. G. “Retrospectives: The Phillips Curve: A Rushed Job?” Journal of Economic Perspectives 25, no. 1 (March 2011): 223–38. pdf / html

• Book Review: myths and macro: macroeconomics and the Phillips curve myth by James Forder. pdf

• Big fall in unemployment with essentially no change in inflation.

• Maybe labor market slack does not matter a lot for inflation (wages rise, profits fall), maybe we are not measuring slack correctly.

• Central bank’s mandate is stable prices and stable employment. Can we even reconcile our entire approach to monetary policy if that tension isn’t there at all? (Dual mandate)

• Yes, there is no reason the Fed should be responding to lower unemployment, if there is no relation between unemployment and inflation.

• We can no longer make policy on the basis that there is a tight relationship between unemployment and inflation.

• Long-run effects of aggregate demand shocks \(\Rightarrow\) Are prices really sticky at a 5-year horizon? (see Bils, Klenow (2004) but also Nakamura, Steinsson’s work)

• Even according to New-Keynesian economists: the welfare costs of price dispersion (which are important in the New-Keynesian model) are very small.

https://www.youtube.com/watch?v=

• The Phillips curve:

  • Phillips probably did not have that much face in the Phillips curve.

  • It became widely accepted after it was introduced in Paul Samuelson’s textbook, and after Samuelson and Solow brought it to America.

  • Taming of the Keynesian revolution ?

• Direct evidence that sticky prices have anything to do with the effects of demand shocks on the economy is actually rather weak:

  • These are the kinds of questions that can be answered using microeconomic level data.

  • However this is the basis for the long run / short run dichotomy that runs to today.