Two conferences straddling the holidays

In case anyone is interested, I'll be presenting at an Infometrics Institute workshop today (here). The topic is information theoretic/maximum entropy econometrics and I'll be presenting my work on a generalized maximum entropy version of propensity score matching. It's still a work in progress (it's received some major changes since the Southerns), but I have high hopes for it.

At the end of January I'll be presenting at an INET-YSI workshop on economic history (here). If you click through the link you'll notice something funny. There's a list of a few "senior participants" that includes many actual economic historians (and historians of the economy) whose names you might even recognize and do seem to merit being called "senior participant". Then there's me. I think this is because the organizer had been asking my about my interest and got a commitment early. Very strange/intimidating. Anyway I'm going to be presenting some work on gross job flows in postbellum manufacturing. I was tempted to add a subtitle "a VERY rough estimate" because the imperfections in the data sources worry me, but I suppose this is par for the course for a lot of economic history.

1920-21 and reasoning from a price change: two recent posts

Two recent posts on monetary policy and 1920-21 by Tom Woods and George Selgin. The thrust of it is some of us (myself included) are, as Scott Sumner would put it, reasoning from a price change. I don't have a strong view of the argument because I haven't had a chance to look at the data. I find Woods's post a little odd - he seems to switch from arguing from a price change to arguing from a quantity change. The other problem here is that even if money were still tight through the recovery, the break in the extremely tight policy still matters. A lot of people think that Bernanke has been tight throughout the recovery, but that is not the same thing as saying that the stark policy changes at the beginning of the crisis didn't prevent a much worse situation. I'm not a monetary economist and I haven't had time to digest all of this, but those are my initial reactions.

I really have to add that Selgin's glib reference to my article (RAE) and note (CJE) on 1920-21* doesn't demonstrate a good grasp of what I've claimed. My point has always been that 1920-21 doesn't disprove Keynesian arguments. I am no critic of the idea that markets can recover on their own, nor am I a critic of the idea that monetary policy can be instrumental in a recovery without fiscal policy.

Anyway - links:
George Selgin
Tom Woods

* - He says I've made "something of a specialty" of this work, which is also odd because most of my research has nothing to do with 1920-21 - it's hardly a specialty of mine.

EJMR post win

As an economist at that transition from PhD to work with an interest in economics of the household and labor economics, and who is also sort of a stay at home dad (much more so last year - though still fairly frequently this year since my schedule is more flexible than Kates'), this EJMR discussion made me smile - particularly the fourth comment down.

If you don't know what EJMR is, don't worry about it. You might be better off.

Cute Caroline pictures from New Mexico

Dissertation proposal and life in the immediate future

Sorry for not updating - a couple people have kindly asked how the proposal went and I fell off the radar a little. It went great - they signed off on it. Somewhat unusually they asked questions as if it were a seminar (i.e., during my presentation rather than afterwards), which threw me at first but it all turned out fine. It felt like a lot of questions and comments, but none of them fundamentally undercut anything I was doing or my approach. Lots of work ahead still of course.

This weekend I'm going to be presenting some work on a generalized maximum entropy version of propensity score matching at the Southern Economic Association conference. I'm chairing a panel on GME. This is work I started last fall and have gotten back to intermittently. I'm still trying to figure out what I think of the simulation results - they're a little mixed (but at least they don't come out completely against the GME set up). It might be worth finishing off as a methods note somewhere. Several of the policy analysis journals have a regular methods note section that I think it could work well for. We'll see.

The week after that I'm presenting work at a National Academy of Engineering workshop on the engineering technician and technologist workforce. I'll be presenting a paper on work-based education and training (internships, apprenticeship, and on-the-job training) to a closed session and a broader paper on the workforce to an open session. Then the following week I'll be presenting my GME work to a methods group seminar here at the Urban Institute.

After those go through I think I'll feel a little less stressed. Of course the Sloan project on the STEM workforce continues, as does the project work I'm picking up at the Urban Institute. The plan is to defend this summer, Sloan will wrap up around then, and then I'm going to be transitioning to full time work at the Urban Institute and hopefully raising some money for projects of my own in short order.

Defending my dissertation proposal today

"Three Essays on Connecting to Work"

Essay 1: The employment and earnings effects of Georgia's job creation tax credit: a regression discontinuity approach.

Essay 2: Educational mismatch and occupational sorting by science and engineering graduates.

Essay 3: Registered apprenticeships and the Great Recession.

Chair: Robert Lerman
Members: Robert Feinberg and Mary Hansen

Essays 1 and 2 are in pretty decent draft form, although some more work to do. Essay 3 is still a little loose. My chair and I have been going through lots of options with it (apprenticeships are his area of expertise). There's simply not a lot of work on apprenticeship in the U.S. - the most important papers, even by American economists, are on European apprenticeship. I have a database of all registered apprentices in the U.S. from 1999 to 2014, so in that sense practically anything I do with it is going to be a contribution. I was at first concerned about thinking of something more methodologically innovative and thinking along those lines, but my chair is really pushing me to do something simple but highly informative. The idea has grown on me. Apprenticeship in the U.S. is heavily concentrated in the construction sector so looking at apprenticeships over the business cycle is particularly interesting right now. I have a job I love - I'm not going on the academic market. My first two essays are methodologically sophisticated (I'm not a superstar, but you know what I mean - thoughtful non-basic methods appropriate to the question that fill a hole in the literature). So I'm digging this approach to the third essay if my chair does.

Some thoughts on Gene Callahan and Francis Fukuyama on job training programs

Gene wanders into some education and training program and federal/local governance tensions stuff in a recent post, and as I'm interested in both issues I thought I'd comment and disagree a little. He writes:

"In a discussion of how the American system of checks-and-balances and federalism produces wildly inefficient legislation, Fukuyama notes that: "Congress created fifty-one separate programs for worker retraining, and eighty-two projects to improve teacher quality." (p. 497)

I have been making this point even before reading this latest work of Fukuyama's. But he has an interesting perspective on why this occurs.

[...]

My own preference would be for worker-retraining and teacher-improvement programs to be implemented at a much more local level (the importance of local knowledge: see Hayek, as well as Catholic social thought on subsidiarity). The federal government should intervene in these issues only to the extent that it redistributes some tax revenues from the richer to the poorest states, to allow the poorer states the resources to implement these goals. But if these things are going to be handled at the federal level, I would much prefer Congress authorized a single agency to deal with each, and empowered that agency to do so.

Fukuyama contends that these legislative Rube Goldberg devices we create arise primarily from the way our system of checks-and-balances and federalism have worked out in practice: multiple branches, agencies, and levels of government are involved with almost every political issue in the United States. Rather than working to limit government, as the founders had intended, this multiplicity of authorities has served to create a byzantine government."

I think federal job training reflect these priorities more than Gene might expect, and the multiplicity of programs is not as pernicious as you might think either (I can't speak for programs to improve teacher quality). There are always things to disagree with, and this has been a process of improvement over time as well, but both of those are only natural.

First, much of the job training that goes on is in fact locally designed and controlled. This happens for at least two reasons. First, the "federal job training programs" we talk about are often better thought of as funding streams rather than programs per se. They'll often be targeted to specific populations (workers displaced by imports, TANF recipients, youth, the unemployed, etc.) and sometimes there may even be restrictions on the spending that goes on (you'll often see requirements that the money be spent on capacity building for the trainer but not tuition, for example). But these are generally existing or newly started training programs at community colleges or other workforce development organizations that are designed locally to meet local needs that then compete for appropriate funding streams from the federal government.

The other major mechanism for local design and control of training programs is good old fashioned devolution. The Workforce Investment Act (WIA) and the new Workforce Investment Opportunity Act (WIOA), which provides a lot of the funding for federal job training are both administered by local Workforce Investment Boards (WIBs), which are composed of employers, educators, and other local stakeholders. WIA/WIOA and many other federal job training efforts have also been pushing sectoral partnerships where employers in important local industry clusters partner with education and training providers to design curricula and programs.

Certainly some training programs are structured at a higher level. I imagine Job Corps is one such program (although I'm not as familiar with its design). But many aren't either by virtue of the funding stream or the structure of the program itself. And the trend is certainly in the direction of decentralization of program design.

The other element of Gene's post is that there are so many different training programs. I think this is a little odd, given his emphasis on local knowledge and local programs. The reason why we have a lot of programs is that workers in different situations have very different needs. Disadvantaged youth need very different training and support services than experienced workers displaced by import competition. I am at a conference right now and I just spoke with a colleague who wants to include me on a proposal to evaluate a training program for older workers, who are going to have different needs and obstacles as well. Needs also vary by industry. Registered apprenticeships are heavily concentrated in construction and to a certain extent manufacturing because those training models work in those fields in a way that might be more difficult for other occupations or industries. The labor market is remarkably diverse, and if you are going to get into the business of job training, as the federal government has, you probably don't want a one-size-fits-all policy. This can lead to headaches too of course, but if we're concerned about Hayek and local knowledge (and if we leave aside Hayek-style libertarianism for a second), there are good reasons to have the sort of system we have.

Caroline's first election

We sat out of the governor's race last year because needless to say things were pretty crazy back then.

She did not get a ballot but she did get a sticker and a stylized explanation of what daddy was doing. Here we're admiring each other's stickers and posing for the camera.

Inflation letter signer James Grant has a new book on the 1920-21 depression and he's talking about it AEI tomorrow

Here.

As some of you may recall, two of my first published articles are on the 1920-21 depression, so this is of some interest to me. Can't go tomorrow - I'm at home with a sick kid while mommy is away on business. The book isn't out yet so of course I haven't read it, but I found this claim of from the write up about the AEI event interesting:

"Grant considers 1920–21 to have been “the last governmentally untreated business depression in America,” yet “by late 1921, a powerful jobs-filled recovery was under way.” This history offers a sharp contrast to and skeptical look at the hyperactive central banking and regulation of our own time."

The Fed wasn't active? In fact the Fed was so active during this episode that Marvin Goodfriend (formerly Richmond Fed, now Carnegie Melon) said of the events that "It is no exaggeration to say that the Fed was traumatized by its first use of interest rate policy."

It is nice he doesn't ascribe the recovery to Harding's fiscal stimulus because (1.) that came on the tax side after the recovery was underway, and (2.)... on the spending side the fiscal story is even more confusing to entertain because Wilson reduced spending much more than Harding but the timing is all wrong for people that want to make this an "expansionary austerity" story. That doesn't stop people from talking up Harding of course. I've got nothing against Harding really, I just don't think he has all that much to do with it. It's really a Fed + natural bounce-back story as far as I can tell.

Anybody that likes John Papola's new video on Elysium needs to google "colonialism".

I just haven't complained about Papola for a while, that's all.


Do people really walk away from that movie thinking it's a criticism of capitalism and technology?

New and speedier modes of transportation

"But chiefly, like his senior countrymen, the young American studies new and speedier modes of transportation. Mistrusting the cunning of his small legs, he wishes to ride on the necks and shoulders of all flesh. The small enchanter nothing can withstand - no seniority of age, no gravity of character; uncles, aunts, grandsires, grandams, fall an easy prey. He conforms to nobody, all conform to him: all caper and make mouths and babble and chirrup to him. On the strongest shoulders he rides, and pulls the hair of laurelled heads."

- Ralph Waldo Emerson, "Domestic Life"

INEQUALITY DEATH SPIRAL!!!... misses the point

I was disheartened to read Kevin Drum write this about the IGM Piketty question today:

"Piketty doesn't say that r > g has been a big driver of income inequality in recent years. He says only that he thinks it will be a big driver in the future. 

This is good clean fun as a gotcha. But liberals should understand that it also exposes one of the biggest weaknesses of Piketty's argument: r > g has been true for centuries, but the rich have not gotten steadily richer over that time. Wealth concentration has stayed roughly the same."

It's nice that it's dawning on more and more people that the IGM survey is not that consequential for Piketty, and it's nice that Drum is spreading that point. But I think he's adding to the confusion by perpetuating this idea that if r > g it means that inequality grows without bound. This narrative is part of what's driving peoples' incredulity about an inequality which (as Debraj Ray has pointed out very clearly) is a standard result that pops out of standard growth models and doesn't have any of the dire inequality death-spiral implications people impute to it.

Piketty doesn't use it to predict a death spiral either. It's one of many fundamental equations he uses to talk about the capital-income ratio and the capital income as share of total income ratio. Rather than obsess over the r > g inequality death spiral stuff, I think people need to spend a little time with this set of equations (and I think guys like Kevin Drum should take the opportunity to walk readers through it). If you made it through middle school, you can handle the math.

First, the share of income from capital of national income (α) is:

α = r*β

Where r is the rate of return on capital and β is the capital-income ratio (the ratio of the capital stock to annual income). This is straightforward, I hope. The capital-income ratio already has national income as its denominator, and the rate of return to capital times the amount of capital you have earning that return is capital income.

Next we have the equation governing β, the capital-income ratio:

β = s/g

g is the growth rate of the economy (national income), and s is the savings rate. Economies that save a lot but don't grow fast will eventually accumulate a large capital stock relative to national income. Of course this can be substituted in the first equation so that we've got both β and α written in terms of the other three variables:

α = (r*s)/g

So whatever r, g, and s are even when r > g, it's important to realize that the capital share of income is going to stabilize at some point. Piketty says this can happen in a number of ways. The classic answer in economics is that r is going to decline (Piketty refers to this as "too much capital kills the return to capital"). It's a diminishing returns story. You could imagine ways that s and g could adjust too either for endogenous reasons (in other words - there's something about the way the economy works that pushes these variables in a certain direction) or for socio-political or technological reasons. And it's likely to be in flux in the real world and across societies of course. But one thing is very clear: r > g does not tell us that capitalists' share just keeps increasing forever and ever - certainly it doesn't tell us that that's a necessity.

Part of the Piketty story is that we are in a period of convergence which is why things are changing now. The wars and the depression wiped out significant portions of the capital stock, and post-war institution subdued convergence back to these steady state values for β and α. As some of these institutions have been dismantled, convergence seems to be happening more rapidly. On top of this we know a couple things:

1. That g is falling simply as a result of the demographic transition, and since g is in the denominator of both β and α, these quantities get less stable as growth slows.

2. Wage income has been an important factor driving inequality in the late twentieth century, and as generations turn over that wage income becomes a new avenue for the fundamental equations above to kick in and begin converging again.

None of this is a death spiral story - it's more of a convergence story. Piketty suggests we might not like what we're converging too and we might want to consider institutional arrangements that might push things in a nicer direction.

Before closing I'd also emphasize a point I've made before on Piketty - the fundamental equations are really about capital income and the capital share, not wealth or income inequality directly. Capital income is a big piece of the puzzle of income inequality particularly because of what we know about the ownership of capital, but inequality is much more institutionally determined than capital dynamics.

Smith and Maskin at the Hayek Event

After the Kirzner talk, and after meeting a great guy with an interesting life story who I had only known online in the lobby during the coffee break, we filed back in to see Ed Phelps, Eric Maskin, and Vernon Smith speak. Except Ed Phelps was ill, which was very disappointing both because it's unfortunate he was ill and also because I had a question prepared for him. Peter Boettke read his remarks, which concerned Hayek and innovation, but my question was sufficiently specific that it didn't make sense to ask it. I was going to note that Hayek is well known to have supported many safety net programs provided that their design conformed to certain requirements for a liberal order. I was going to ask about Phelps's own proposal of low income wage subsidies (which I like as well, and which I'm writing a dissertation chapter on), and whether he thought that would conform to Hayek's requirements and how he thinks Hayek would respond to it.

After Pete delivered Phelps's remarks, Eric Maskin had an interesting discussion about mechanism design work that he thinks formalizes a lot of Hayek's insights on the uses of knowledge and the market's ability to economize on knowledge. I am not familiar with the work but the models seem to work a lot like a game theory model because you've got normal optimizing behavior but then you also have a message space (ability to send and receive certain kinds of messages) and an outcome function that translates those messages into outcomes. The work he discussed demonstrated Hayek's point that under certain conditions the market is the most efficient at using information - all non-market options required more channels for the information to move along than the market.

This is all interesting stuff, but it seemed like Arrow-Debreu for information, which is to say it didn't feel very Hayekian (or Kirznerian). Arnold Kling, in the audience, had the same thought and challenged Maskin on the point. I forgot the exact response but I believe he generally agreed that yes it's a very formal model which was different but still captured a lot of the same ideas. I was going to ask the same sort of question as Arnold but didn't get the chance (George Selgin got the last comment).

I was going to remark that I was anticipating that Maskin would have talked about mechanism design in terms of the rules of the game and (to put a more Buchananesque spin on it in honor of his recent birthday) constitutional order. With mechanism design you are asking - given the incentives and behavior of the agents, what arrangement of message spaces and rules will produce the outcome that you want. This is the same idea behind Buchanan's constitutional exercise or really any situation where you are thinking about how the rules of the game determine the outcomes (or possible set of outcomes) of the game.

I have less to say about Vernon Smith's talk. It was very nice of course and I agreed with most everything he said. He presented some interesting evidence that Hayek was skeptical of experimental testing of theoretical claims. I'm not sure how firmly Hayek held that view or if it was just a little methodological bluster, but it was still an interesting bit that he shared. Smith maintained a narrative you hear sometimes from Austrians that back in the day economists really were skeptical that markets worked. I have serious doubts when I hear these things, and I think some libertarian types tend to conflate trust in government during this period with rampant doubts about the market. Of course proving this one way or another requires a lot more than the anecdotes that are usually brought to bear.

Clarifying Kirzner before moving on to the laureates

I want to do a quick summation of what I've claimed about Kirzner to avoid confusion before sharing a few thoughts on the Nobel laureates at the talk on Thursday.

I want to make it clear that Kirzner does more work on the area of how we get to equilibrium and the role of the entrepreneur in getting to equilibrium than most mainstream economists. Brad DeLong points out in the comments that Frank Fisher is an important exception. He's talked about Fisher's work here before. This is similar to what I've said in my post on dynamics. We do talk all the time about how outside of equilibrium there are arbitrage opportunities that introduce the incentive to converge (or not) to equilibrium. Of course Fisher and Kirzner (and Brad DeLong) certainly others spend more time thinking about that than most of the rest of us. But this is quite different from the suggestions by Kirzner the other day that mainstream economists are missing something fundamental. So the message very much isn't "Kirzner is no good". The message I'm trying to get across is "Kirzner is not being fair in how he handles mainstream work". If he were to just say "I'm interested in this one problem that mainstream economists don't spend as much time on" that would be many times better than the sort of story he is currently spinning.

And I don't see what's wrong with saying that instead. It's more accurate and more humble.

Anyway, Austrians that like Kirzner tend to think that there is revolutionary potential in all this. Kirzner himself likes to say it's "radical". I think this needs to be more carefully assessed. If you strip out everything all economists agree on (but may spend somewhat less time on) from Kirzner - arbitrage behavior in disequilibrium that helps to get the system to equilibrium - what is really left of Kirzner to be "radical"? Advocates more familiar with Kirzner than me have to answer that question. My impression is not that much because none of his advocates have given me a reason to think otherwise (and they have an incentive to get me to think otherwise).

And please don't waste everyone's time with an answer about arbitrage out of equilibrium. Everyone knows that. That's pretty much the definition of "disequilibrium".

More thoughts on Kirzner: I'm not special

Bob Murphy played to my vanity in the prior post with this comment:

"Let me step out of character for a moment and compliment you [I don't think that's all that out of character - DK]: You are a "deep" kind of guy who likes to think about what he's doing. You spend a lot of time at my blog keeping tabs on how those wacky Austro-libertarians look at the world, you read Sumner to see what mischief he's raising today, you read Boettke and Boudreaux to see how they are straw-manning people this morning... You get the point (and I'm trying to be funny), you spend a lot of time thinking through stuff. Most people--including economists--don't do that.

So where am I going with this? The fact that you asked your micro class to think about finding equilibrium doesn't mean too much. It would be like me saying, "People say Austrians don't use math, but I taught a game theory class at Hillsdale." You are not a proxy for "the mainstream" since you keep abreast of a lot of approaches and like to think through what you're doing. You sort of gave away the game when you said, "But when we moved to Slutsky equation I lost them..." (or whatever). That's just what the Austrians say: They are doing intuitive, real-world economics, while mainstream does formal math models that are confusing and pointless.

He is referring to a point I made about how in a micro class I was teaching the week prior to the Kirzner lecture I asked them why they thought agents would grope toward equilibrium, what the incentives were for doing so, etc. - and that they gave (somewhat unsophisticated of course) market process answers.

Here's the thing, while I'd like to think I'd ask that anyway I didn't make that question off of the top of my head. I was covering a class for my adviser and I used his slides, and he used the textbook company's slides. Of course I guided the discussion how I chose to guide it but all of it was in the slides. My point still stands about the value of Kirzner: he thinks more deeply about this than most other economists. But the point is I'm not special. I genuinely think economists generally acknowledge the major points of market process theory, although of course they don't focus on it the same way. Very much like - as I alluded to in the last post - Newton acknowledged the reality of gravity and if I recall corresponded with people about possible explanations, but didn't worry so much about nailing that part of the problem down when he wrote up the Principia.

I'm not special. I'm not a great economist, I'm average and adequate at what I do. I didn't go to great schools, although I have nothing to complain about regarding my education. William and Mary especially is a very high quality school but the economics department, largely because it didn't have a PhD program, wasn't a superstar program or anything. With one exception* nothing I've come across in my education has been exceptional. I've used standard textbooks, had regular professors who generally had regular backgrounds themselves. They were very good professors of course but if you go to three schools you're bound to come across several of those (I had some bad professors too).

If I went to a Harvard or a Chicago I would worry that my outlook resulted from an exceptional background in some way - that I couldn't generalize from my experience to "standard economics education". But I don't have that background and I think I can say my experience is fairly typical (minus the unusual gender and Post-Keynesian, and even history of thought stuff I'm getting at AU, of course).

I think a much better explanation is that Kirzner is discounting the mainstream too much in a way that highlights his own contributions. Clearly the mainstream doesn't focus on Kirzner's research agenda with the energy that Kirzner focuses on Kirzner's research agenda. That's obviously true. But it seems to me that's a very different claim from the sorts that Kirzner was making the other day.

* The only thing close to a "best in the field" I've come into close contact with has been my work with Burt Barnow, who is one of the top experts in the job training literature.

More thoughts on Kirzner: Incommensurability

Thomas Kuhn liked to remind his readers that Newton didn't have much to say about gravity.


That sounds odd to most people, but if you know the argument it makes more sense. What Kuhn meant was that for Newton gravity may have been very important but it was just assumed. There was no great effort expended on figuring out why it was the way it was and where it came from, etc. Although the idea of incommensurate scientific paradigms had to do with many things, this fundamental point that different paradigms sought to explain different pieces of the puzzle was an important one.


Einstein wanted to explain gravity and that was a major element of what separated Newtonian from post-Newtonian physics.


I think it's instructive to think about Kirzner's work on the market process in these terms. Economists aren't dunces. They know there is a market process operating in the world. But they're like Newton in that they don't have much to say about it. Kirzner has a lot to say about it and doesn't care very much for everything the mainstream has to say about equilibrium models, despite the fact that many reasonable people insist that you can get a lot of important mileage out of those models! It doesn't matter. Kirzner says a fundamental point is being neglected.


In prior posts I confessed skepticism about the importance of Kirzner's departure from the mainstream. However, if I'm right here that the market process is analogous to gravity it means that Kirzner is far more significant insofar as he might represent a new paradigm for thinking about the economy rather than simply a scholar interested in a side-point that most people acknowledge but don't think is worth delving into in any detail.


It's certainly worth a thought.


So if the mainstream is Newton, Kirzner is Einstein, and the market process is gravity that bodes really well for the modern Austrian school, right?


Maybe. Maybe not.


The first problem is that you need more for a paradigm shift than just focusing on something that other people don't focus on. It needs to be something which, when attention is turned to it, you are able to explain paradoxes that the existing paradigm struggles with. Does market process work fit the bill? Ehhh... I'm not so sure. Nothing obvious springs to mind. Certainly none of the things that really puzzle mainstream economists seem to be suddenly solved by market process theory. I'm happy to hear candidates in the comments, but let's be very specific please. Of course the market process undergird all market activity but grandiose talk like that doesn't answer how it address specific scientific puzzles.


The second problem, of course, is that assigning the mainstream to Newton and Kirzner to Einstein is not the only option available. Kuhn talks about how Descartes and others with a mechanical theory of gravity offered (like Einstein but unlike Newton) an explanation of gravity rather than just responding to the problem with hand-waving. And we all know what happened to the Cartesian theory of gravity: nothing.


So is Kirzner a Descartes (or worse, a post-Newtonian Cartesian!) or is he an Einstein?

More thoughts on Israel Kirzner: Dynamics

A couple days ago Pete Boettke shared speculation from Thomson Reuters that Kirzner could win the Nobel this year along with Baumol. I have no thoughts on that - I don't know his work well enough to assess its merits. But that post and yesterday's events got me thinking more about Kirzner than I typically do, and one thing that I've been puzzling over (but didn't have well formulated enough to ask him yesterday afternoon) was what Kirzner would think of "dynamic equilibrium" and really the transition dynamics of that sort of model.


As I noted before, Kirzner's concerned with out-of-equilibrium behavior and if there is convergence to an equilibrium how that behavior gets us there. Contrary to Kirzner's own assertions this is not something that the mainstream is unconcerned with. One answer to this question that has been particularly amenable to modeling is the idea of transition dynamics and dynamic equilibrium. As far as Kirzner's reservations about equilibrium economics go it's something of a misnomer. On the stable arm nothing is stationary, people often aren't satisfied and they aren't finished doing things. But they are acting rationally, and when we identify dynamic equilibrium we are talking about a sequence of rational decisions that lead to a more stable equilibrium. The rapidity of convergence depends on various conditions.


Kirzner is very skeptical of the mainstream theoretical apparatus so I doubt he would think much of the point. But I do wonder what people who see things a little differently but who still appreciate what Kirzner has to say think about how transition dynamics in these models relate to his thinking about the market process. What are agents doing and thinking in dynamic equilibrium that's similar to what they're doing and thinking for Kirzner, etc.


As a side note, Vernon Smith made a vague reference to my line of thinking here in his speech (after Kirzner's). He started by talking about how he's been right a lot in his career, but he's also been wrong a lot and how he doesn't know much about the long-term future of things but he does know the next step and if he takes a series of good next steps he gets along pretty well (he broadened this point to people in general who get along pretty well in the world).


Too me this sounded in a very rough way like Smith was solving a Bellman equation. In this approach to dynamic programming you just worry about being optimal at every point in time. The future is nicely tucked away in the value function and you come to that when the future comes around. You don't waste time or energy worrying about planning and optimizing a long stream of decisions.

Forty Years After the Hayek Nobel: Thoughts on Israel Kirzner

Yesterday I attended an event at George Mason University celebrating the fortieth anniversary of Hayek's Nobel Prize. There were two sessions open without invitation - a keynote by Israel Kirzner and a panel discussion with Eric Maskin, Vernon Smith, and Ed Phelps. I was very much looking forward to hearing Phelps but unfortunately he was ill and his remarks were read. I'll talk about my thoughts on the Kirzner session in this post, and the laureates' session in another.

Israel Kirzner, professor at NYU, was described by Peter Boettke in his introductory remarks as the leading light of the modern Austrian school. Kirzner's work focuses on "the market process" (essentially how agents get to equilibrium - or at least how they get to wherever they're getting to) and the role of entrepreneurship in the market process. Kirzner is very much in that line of Austrians where, if you tell him you're a subjectivist he'd trump that by insisting that he (and not you) is a radical subjectivist. Indeed, "radical" came up several times in his talk, primarily to describe the advances made by Hayek and Mises in the 1937 to 1945 period. Kirzner presented what he called a revisionist history of thought to explain the lack of appreciation of Austrian economics between the late 1930s and the 1970s and the reason for the Austrian revival in the 1970s.

Kirzner's proposition is that after the debate with Keynes Hayek and Mises both turned their attention to other matters and the result was a "radical" advance in our understanding of the market process through Hayek's work on knowledge and Mises's work on socialist calculation and Human Action. Allegedly the mainstream did not appreciate how radical these contributions were and so they missed the boat until forty years later Hayek got the Nobel (for other work), the mainstream refocused their attention on the Austrians, and economists like Kirzner, Lachmann, O'Driscoll, Rizzo, and others were ready to demonstrate what the fruitful advances of 1937-1945 really had to offer. The lull and revival was therefore not all that surprising, and it mainly rested on the failures of the mainstream rather than the failures of the Austrians (a rather attractive narrative for an Austrian of course!).

I don't entirely buy this revisionist history, but what I do like about it is that it refocuses us on the work on knowledge, subjectivism, and economic calculation. I suspect the lull in interest in the Austrian school had far more to do with the failure of Austrian macroeconomics than the failure of the mainstream to appreciate this other work, but I like the opportunity to put the 1937-1945 work center stage nonetheless.

What bothers me about the revisionist account is that it relies too heavily on an implausible story about how mainstream economics is full of dunces. Kirzner argues that mainstream economists are preoccupied with equilibrium models where genuine competition and discovery doesn't really go on and most importantly nobody talks about how you get to equilibrium. There is a germ of truth to this insofar as mainstream economists don't spend a large share of their time on this problem (Kirzner does), but the idea that the market process is lost on them strikes me as misleading at best and borderline libelous at worst. I had to laugh to myself when Kirzner went through these points because just a week ago when I was covering an intro micro class for my adviser we were talking about market equilibrium and optimal decision making, and I posed precisely this question to them - what do agents do when they're not at an equilibrium that gets them to equilibrium? The students had a much easier time providing sound answers to that question than when I threw the Slutsky decomposition at them later in the discussion, and the answers more or less conformed to what Kirzner presents. What's more I think every economist has these market process stories in mind when they think about why getting to equilibrium (even if it's a constantly moving target) is reasonable.

I've made this point about Kirzner before (and it's worth saying at this point that I haven't read a lot of him so if someone that has has thoughts to add, please do), and often people think I'm denigrating the guy. I don't think my point should be thought of in this way. It's quite clear that Kirzner has thought about the market process in more depth and in different ways than other economists. He definitely deserves credit for that. What I challenge is the idea that these fundamental points are lost on the profession, or that the profession has gone down the wrong path by working with models that include a lot of equilibria. It should also be clear that I'm challenging the idea that any of this is really all that "radical".

So far I have a disagreement in the emphases of Kirzner. But I also had a problem with many of his actual claims. One astonishing thing he said was that it is a disequilibrium situation when one agent subjectively values the production of a good at $50 while another subjectively values the use of that good at $100. The entrepreneur, in pursuit of profit, takes advantage of this "arbitrage" opportunity, but an equilibrium perspective misses this entire dynamic that's at the heart of the market process. This is nonsense (although it's possible he didn't explain it as clearly as he wanted to). Even if we imagine a market in stable, boring ol' equilibrium there are going to exist agents that differentially value goods in this way. We call the difference between those values and the market price "surplus", and there's nothing at all outlandish about this point. When Kirzner calls this a "disequilibrium" he is confusing values with prices. Values never have to be brought into equilibrium with each other. A price establishes an equilibrium of behavior in the context of widely varying valuations that are likely to continue to be widely varying. The only sense in which we can talk about values being brought into equilibrium is in the case of the marginal good sold, but even that isn't really bringing values into (out of) equilibrium (disequilibrium), it's simply a byproduct of the marginal behavior of rational actors. So this was just an abuse of concepts.

Another thing I actively disliked about the talk was the idea that the mainstream relies on perfect competition, fully informed homogenous agents, and zero profits. We teach freshman some very dumb models that look like this, but for Kirzner to indict the mainstream of the profession along these lines is not becoming of a guy that's supposed to be the modern leader of the Austrian school. This is the stuff of internet Austrians.

Kirzner is clearly a very intelligent man, and he was an interesting speaker. I think he's thought more deeply about the market process and the economic function of entrepreneurs than most anyone. If I had the time to work through his writing, I'm sure I'd find a lot of value along these lines. But I think his vision of his own research program is deeply problematic and too easily discounts how interesting and intelligent his fellow economists are.

It's Caroline Joy Kuehn's first birthday today!

Hard to believe it's been a year.

Brief Thoughts on Piketty on EconTalk

Piketty does a great job on EconTalk, discussing his book with Russ Roberts. This was my favorite part of the whole discussion. It comes after Russ is asking about people who get wealthy in various ways - including very legitimate ways. I think this encapsulates so many of the criticisms of the book:

"Roberts: But I think as economists we should be careful about what the causal mechanism is. It matters a lot.

Piketty: Oh, yes, yes, yes. But this is why my book is long, because I talk a lot about this mechanism."

The book is long for at least two reasons. First I think he adds a bunch of stuff in there that doesn't need to be in there (the policy stuff, the discussion of the social state, could probably all be in a separate book - he could probably cut a third of the book by removing this material). But the second reason is that he is far more exhaustive than many of his critics seem to give him credit for. There is this notion that the book is all about inheritance and ill-gotten gains. The latter is a relatively small discussion and the former is a more sizable discussion but comes way late in the book and is not some kind of exclusive focus.

Generally I think this was a great EconTalk. My only criticism is along these lines. Several times Russ chimed in with a different version of "but this guy is wealthy because he improved the world!", and each time Piketty basically said "right, I agree, and I've never challenged the point" (of course it's Piketty so he spends much longer saying that). If Russ didn't keep asking those questions or if Piketty just replied "asked and answered" I think they could have gotten much deeper into the material. But still a very nice talk.

New Review of Industial Organization article is up!

It's not assigned to an issue yet, but a paper I co-authored titled Explaining Variation in Title Charges: A Study of Five Metropolitan Residential Real Estate Markets is available here.


It's an interesting situation - you'll notice I have two affiliations (American University and Urban Institute). This work started several years ago as a project for the Department of Housing and Urban Development when I was at the Urban Institute. Since then I left for AU and now have put the finishing touches on it back at the Urban Institute after being gone for three years.


The lead author, Bob Feinberg, is a great guy that's on my dissertation committee. I can't speak highly enough of two other co-authors, Signe-Mary and Doug, both at Urban. I've learned at least as much econometrics from Doug Wissoker as I have from any of my econometrics professors (and that's a compliment to Doug, not a knock on my econometrics professors who have really all been excellent). Sisi was at the Urban Institute, and is now teaching in China.

An alternative Venn Diagram for Mark Perry

I really hope I don't have to explain to everyone what's so wrong about this post by Mark Perry on the minimum wage.

All the law of demand says is that demand curves slope down.

No one that I know that is doubtful about modest minimum wages hurting employment disagrees that demand curves slope down. If you think they are arguing demand curves slope up you need work a little harder at understanding the conversation you are inserting yourself into.

Documents on Koch intentions on FSU econ department hiring

Here.

Note, this is an internal memo about the Kochs' expectations. Because of the outrage this caused (even in the absence of these documents) the advisory group was eventually restricted in how much they could impact these decisions.

This is really not good for anyone that cares about economics as an objective science and people who receive Koch money (which is not inherently bad at all of course), should be saying that.

If movies tell me anything it's that the Sudanese need to watch out

My minimum wage paper is out at EPI

You can find it here. The idea is to communicate to a broad audience the fact that the "credibility revolution" in econometrics matters a great deal for the minimum wage debate, and that if we divide studies according to whether they employ quasi-experimental methods or fixed effects models the quasi-experimental methods (which are strongly preferred) tend to produce the "no disemployment effect" results. That should matter for the debate.

I also include some cautions about how to apply this research to policy. These are every bit as important. I've had one discussion with a journalist so far about the paper and the fast-food strike for a $15 minimum. I did the math for him on how big an increase that $15 would entail and compared it to Figure A in my paper and flatly told him that you can't justify this with the existing research - our strong priors ought to be that it will reduce employment, with perhaps a few high wage metropolitan areas as the exception.

An excerpt from the report I like ("matching methods" is a more user-friendly term that I use to talk about quasi-experimental methods - that is all well-defined up front and defined in even more detail in the endnotes - the idea is that in all quasi-experimental methods you are matching some treatment case to some comparison case):

"It is difficult to overstate how uncontroversial it is in the field of labor market policy evaluation to assert the superiority of matching methods to the nonmatching approaches described above.⁹ The seminal evaluations of the effects of job training programs, work-sharing arrangements, employment tax credits, educational interventions, and housing vouchers all use at least some sort of matching method, if not an actual randomized experiment. In their widely cited survey article on non-experimental evaluation, Blundell and Costa Dias (2000) do not even mention state-level fixed-effects models when they list the five major categories of evaluation methods. In a similar article, Imbens and Wooldridge (2009) do mention fixed-effects models as a tool for policy evaluation, but clarify that these were used before more advanced methods were developed, noting that the modern use of fixed-effects models is typically in combination with other more sophisticated techniques. For example, Dube, Lester, and Reich (2010) also use a fixed-effects model, but more importantly it is a fixed-effects model that utilizes rigorous matching strategy to identify the effect of the minimum wage. Sometimes fixed-effects models are the best available option if no natural experiment or other matching opportunity emerges to provide a more rigorous approach. Well specified fixed-effects models can still be informative. But faced with the choice between a well matched comparison group and a fixed-effects model, the former is unambiguously the stronger study design."

Yes, Acemoglu and Robinson's review of Piketty is very strange

I'm only about two thirds done with Piketty - it's been very busy this summer between events, getting the dissertation proposal off the ground, and starting work again at the Urban Institute. But I just happened to get to one of the parts in Piketty that Acemoglu and Robinson quote, and it turns out to be an extremely dishonest rendition. They quote this to show that Piketty doesn't think institutions matter (from page 365): 

"The fundamental inequality r > g can explain the very high level of capital inequality observed in the nineteenth century, and thus in a sense the failure of the French revolution.... The formal nature of the regime was of little moment compared with the inequality r > g.". 

So what is in that ellipses? He explains that the revolution didn't change the course of inequality (relative to monarchical Britain) because the new institutions that were established were much closer to Britain than popular perception in France at the time suggested! It was NOT a big change in institutions, which was why the French revolution did not shift the parameters of the model. Immediately after this he goes on to discuss changes in institutions in the 20th century that WERE substantial enough to impact inequality, and he even reviews how inter-country differences in these institutions explain differences between (for example) Germany and France.

In other words, the real point of this section is that institutions matter a lot, regardless of what the hype and propaganda around the Revolution really said. And not only did A&R get that wrong - they deliberately removed the portion of the quote where he made the point.

I have always taken one of the central theses of Piketty's book to be that institutions are central in shaping wealth and income distributions. He says that over and over again. All of the explanations for the empirical changes in the distribution over time are either (1.) institutions, or (2.) shocks (which, given the nature of these shocks, inevitably also have institutional origin). Apparently it's not just Acemoglu and Robinson that missed this memo. I have since had conversations with people who suggest that discussion of institutional determinants of inequality is minimal and that Piketty is just "covering his butt" when he mentions it. But as far as I can tell that's the whole point - the analysis is grounded in inequality.

Piketty without institutions in the capital share of income section could probably survive. Piketty without institutions in the inequality section of the book simply wouldn't exist any more. I mean, you'd have the data I guess, but the analysis is entirely institutional until you get to the last third of the book where he brings some of the subsumed Solow model (all that r > g stuff) back in to talk about with institutions

"Cover your butt" for these people seems to mean "have as your main emphasis for several hundred pages". This is like saying Milton Friedman wasn't all that concerned with money!

Am I the only one to find the Acemoglu and Robinson review of Piketty strange?

I have taken one of the central tenets of Piketty to be that institutions are central to the determination of wealth and income inequality. The "laws of capitalism" act on capital ratios and even the capital share of income, but given an institutional environment that determines r (in conjunction, of course, with technology itself). And certainly institutions determine wealth and income distributions more broadly.

That's like the one thing that he says over and over and over again: institutions, institutions, institutions.

But Acemoglu and Robinson have a review out that seems like it has a lot of interesting stuff on the focus on the top shares, etc., but that centrally claims that Piketty doesn't think institutions matter.

This seems really strange to me.

Reswitching and the Minimum Wage: An Austrian doing Sraffian Economics that is not Bob Murphy

Don Boudreaux walks through an interesting exercise where the minimum wage leads to switching between two production techniques as a possible reason for increased employment as a result of the minimum wage. The logic from Don is as follows:

"Suppose that the two lowest-cost options for Acme Co. to produce Q amount of output X are as follows (and reckoned on an hourly cost basis):

1)  10 hours of low-skilled labor combined with 50 dollars of capital expenses;

2) 11 hours of skilled labor combined with 30 dollars of capital expenses.

If the prevailing hourly wage for low-skilled workers is $7.25, then Acme Co.’s hourly production costs will be $122.50 if it goes with option 1.  ($72.50 for ten hours of low-skilled labor plus $50 of capital expenses.)  If the prevailing hourly wage for skilled workers is $8.41 or higher, then Acme will use option 1; it will produce X using low-skilled rather than skilled labor.  (If Acme employs 11 skilled workers at $8.41 per hour, and uses with these workers $30 of capital every hour, Acme’s hourly production costs are $122.51 – higher than the total costs of hiring ten low-skilled workers at $7.25 per hour along with $50 worth of capital each hour.)

Now let the minimum wage be raised to (say) $8.41 per hour.  If Acme continues to produce Q amount of X each hour by employing ten low-skilled workers, along with $50 worth of capital, Acme’s hourly production costs would rise from $122.50 to $134.10.  (Ten low-skilled workers at $8.41 per hour = $84.10; adding $50 of hourly capital expenses sums to $134.10 per hour.)  But by instead employing 11 skilled workers at $8.41 per hour, along with $30 worth of capital, Acme’s hourly production costs will rise only by one cent, to $122.51."

First, I want to give kudos to Don for spelling this out when many people (myself included) were confused by a previous post where he said that increased supply from a minimum wage might increase overall employment. Actually that still confuses me and it's not at all what he has here (here it's a demand shock, not a supply shock that's occurring). This provides a sensible (likelihood is another question I'll get to in a moment) explanation of a result that empirical analyses seem to point to - and a result that is not one that is particularly amenable to Don's own views on the minimum wage as policy.

It's also interesting, though, because reswitching situations like this are typically highlighted by left-heterodox economists and Sraffians, most notably during the Cambridge capital controversy. For all Don complains about fairly standard models with turnover, fixed hiring costs, and monopsony power as explanations of the minimum wage, this invocation of reswitching is a much bigger departure from received neoclassical economics.

So what do we make of it? In practice I doubt it's a major contributor to the lack of a disemployment effect in the best empirical analyses. A lot of the studies have focused on low-skill service sector work where the opportunity for this sort of reswitching seems like it would be minimal. It seems like it would be much easier as a manager to make low-skill workers more productive than it would be to change a production process, particularly because the reswitching usually involves a capital-labor substitution of some sort. Add in the fixed costs of making the switch in the first place and it just doesn't seem likely. But if there are any good examples where something like this is going on that would be really interesting and I'd love to hear about it. The result is so anomalous I think it's likely that lots of things are going on to drive the result and this might be part of the puzzle.

My review of Peter Boettke's book "Living Economics"

Is here.

Some outtakes:

"Peter Boettke’s Living Economics gets off to an inauspicious start. Although the book’s principal plea is for people to “live” economics passionately, it begins with a rhetorical assault on one of the greatest and most passionate practitioners of economics in the history of the science, John Maynard Keynes. To the average economist or economics student, Boettke seems to be sending mixed signals from the outset. Are we supposed to be “living economics” or policing ourselves for any traces of Keynesianism—or “mainstream economics”, or “market failure”, etc.?"

And:

"Credulous readers of Boettke are likely to walk away with the impression that a “Smithian Keynesian” is an oxymoron. Such credulous readers will find themselves woefully unprepared for real world interactions with economists outside the George Mason University orbit. Rather than engage those who see things differently as scientists, Boettke unfortunately chooses to brands their views as “dogma” (p. 304) or a “disease on the body politic” (p. 12). This is not just my interpretation. A more sympathetic David Gordon, in his review of the book, describes Boettke as waging “a battle” against “false doctrine”, a doctrine that is promoted in a “quest” for a “false god”.

It’s little wonder that Boettke occasionally feels that his perspective on economics is marginalized! Who would want to talk economics with someone that’s going to call them a dogmatist or wage a battle against them, and then present said battle to students as good economics?"

Krugman's other forays into public choice

David Henderson rightly praises a recent post by Paul Krugman on the motivations to go to war, and notes the use of public choice logic in the post. Really it's just good old fashioned political economy. "Public choice" is more a name for a particular group of political economists and the literature they produce, but the approach of explaining the incentives of "the sovereign" is long-standing. I agree with David it was a great piece on war, but I have a different favorite Krugman foray into public choice - one that I think is in woeful need of elaboration by other economists: his discussion of public choice explanations of austerity.

Public choice dealings with fiscal policy I think have had a lot more success as micro explanations - explaining why certain spending decisions get made or not - than as macro explanations of the broader fiscal stance. My favorite illustration of this is Democracy in Deficit, published by Buchanan and Wagner in 1977 to explain oh how awful Keynes was for fiscal responsibility. Publication of the book came after several decades of declining federal debt as a share of GDP, right before debt as a share of GDP would reach its lowest point in the post-war period in 1981 (and right after a very-close-to-lowest-point in 1974). After the late 1970s when Keynes was tossed as a guide for fiscal policy, monetary policy ruled the macro-stabilization roost, and tax and spending decisions were made on a non-Keynesian basis of course the debt began to climb rapidly. I'm not claiming the debt burden will never climb under Keynesian principles. It ought to sometimes! But the entire public choice framework for thinking about fiscal policy from a macro perspective was completely out of sync with what was going on in the real world, outside their office windows.

Enter Paul Krugman.

A year ago (almost exactly a year ago, as it happens), Paul Krugman was blogging about an issue that has bugged me for a while now - what is a good economic explanation for why politicians are embracing austerity? Why has federal spending flat-lined in the midst of a depression? Why have we been flirting with and actually imposing shut-downs. Why the sequestration? And why have comparable policies been put in place in Europe? It is perhaps the most important public choice/political economy problems of our time but we aren't making nearly as much progress on the answer as we are on more standard macro questions (like how monetary and fiscal policy work in a liquidity trap). Krugman decided to reach back to Kalecki (1943) for insights, following Mike Konczal's lead (as well as Naomi Klein, but I think Kalecki is the more fertile route for academics). A sampling:

"Noah Smith recently offered an interesting take on the real reasons austerity garners so much support from elites, no matter hw badly it fails in practice. Elites, he argues, see economic distress as an opportunity to push through “reforms” — which basically means changes they want, which may or may not actually serve the interest of promoting economic growth — and oppose any policies that might mitigate crisis without the need for these changes... And the lineage goes back even further. Two and a half years ago Mike Konczal reminded us of a classic 1943 (!) essay by Michal Kalecki, who suggested that business interests hate Keynesian economics because they fear that it might work — and in so doing mean that politicians would no longer have to abase themselves before businessmen in the name of preserving confidence."

I think this explanation has potential merit in particular cases. A simpler, general explanation is of course that voters have an antipathy to deficits and often analogize governments to households and perhaps the political system is responding to those demands accordingly. It's a little unsatisfying for an economist because the argument is based on preferences and ignorance, but "unsatisfying for economists" is not always the same thing as "wrong". In that case, the answer is perhaps stronger economics education.

I am not sure we have a great answer yet - it needs more work (perhaps Econlib can spearhead something, David?). But I do believe that getting a grip on the political economy of austerity is one of the more important questions that economists are going to have to grapple with. I can muse but my day to day work is in empirical labor stuff and I am getting less scope to be creative lately (hopefully once a few obligations have passed that might change a little). What we need is someone with expertise in public choice and political economy to tackle it. Any takers?

Two more points on the Phillips Curve discussion

I know this Magness guy is really not worth the time investment, but before I leave this behind I wanted to share this great passage from Samuelson-Solow on the difficulty of pinning down microfoundations (which, as you'll recall from the last post, is the point of the paper - to discuss competing microfoundational explanations of the Phillips Curve floating around in the 50s). From page 191:

"We have concluded that it is not possible on the basis of a priori reasoning to reject either the demand-pull or cost-push hypothesis, or the variants of the latter such as demand-shift. We have also argued that the empirical identifications needed to distinguish between these hypotheses may be quite impossible from the experience of macrodata that is available to us; and that, while use of microdata might throw additional light on the problem, even here identification is fraught with difficulties and ambiguities."

They go on to talk about a hypothetical natural experiment (they don't use that term obviously) and how it could potentially sort things out.

This is, of course, the Lucas critique. It just took Lucas to really make it stick.

The second point I want to make is that when you're talking about history of thought you really need to distinguish between what contribution (say) Friedman actually made to the discussion and what contribution Friedman said he made (or even what contribution the textbook or the Nobel prize committee said he made... because you don't do intellectual history by polling practitioners). It's trivial to find Friedman saying those crazy Keynesians didn't realize the Phillips Curve isn't stable. If the question is "how did Friedman describe his own research program" that has a different answer from the question of "how did Friedman fit into the history of the Phillips Curve".

Also, my daughter is a natural born empirical economist

 

May or may not be posed

The history of economic thought is not a food fight: Phillips Curve edition

One thing I hate and tried to teach my students to avoid in the History of Economic Thought class is the tendency to view intellectual history as a food fight - some kind of extended battle between the good guys and the bad guys. A great example of this is the Keynesv. Hayek rap and the whole idea that this is a fight stretching over the centuries. Of course there are disagreements - and certainly there was a disagreement between Keynes and Hayek - but nothing like these epic battles which dumb down the actual scientific discussion. This weekend I got into an argument with Phil Magness, a program director at the Institute for Humane Studies, about the Phillips Curve. He sees the history of the Phillips Curve very much in these terms: a Keynesian vs. non-Keynesian fight where Keynesians opportunistically used relationships in the data to push a policy preference. Friedman, Phelps, and Lucas came in to save the day and destroy the Phillips Curve, and nobody makes use of the Phillips Curve now except for "peripheral Keynesians" (his words).

Two notes: (1.) This will be long, but I’m going to divide it into sections to help focus on the main points. So if you’re not going to bother reading it all, please at least skim the section headings. (2.) None of this is hidden knowledge or original digging on my part – in fact I think it’s fairly widely known among people that care about this stuff. A lot of this is pulled from  Leeson and Young's (2008) "Mythical Expectations", Robert Gordon's (2011) "The History of the Phillips Curve: Consensus and Bifurcation", several articles by James Forder, and some from the primary sources. I'm not going to cite them formally below because this is not a formal write-up.

This is written sort of on the fly. There are a lot of subtle differences between these perspectives (prices vs. wages, direction of causality, reasons for LR/SR differences, etc.) so if some of it is a bit off don’t get too upset with me and let me know so I can adjust.

+++++++++++++++++++++++++++++++++++++++++++++++

"No one supposes that a good induction can be arrived at merely by counting cases. The business of strengthening the argument chiefly consists in determining whether the alleged association is stable, when accompanying conditions are varied"

- John Maynard Keynes, 1921

+++++++++++++++++++++++++++++++++++++++++++++++

1. Expectations augmentation did not start with Friedman and Phelps.

 Expectations have been important to economists for a long time. Malthus, Ricardo, and Bastiat all extensively discussed how taking expectations about the future into account often changes results in static models or models that don't include expectations. When it comes to expectations in macroeconomics, this was not new in the 1960s either.

The two really obvious cases are Keynes (1936) and Hayek (1937). Expectations play an enormous role in the General Theory in determining policy effectiveness. Keynes's interest in expectations and belief formation generally go back to his Treatise on Probability, some common interests with Frank Ramsey, etc. This is all very well known, and it was at the time. Hicks said in his review of the General Theory that 'From the standpoint of pure theory, the use of the method of expectations is perhaps the most revolutionary thing about this book' (see Forder, "The Historical Place of the Friedman-Phelps Expectations Critique"). For Keynes expectations fed primarily into entrepreneur's investment decisions and the liquidity preference function. They played less of a role in his analysis of consumption, at least in the General Theory (he seems to get at some of these ideas as they relate to consumption in How to Pay for the War, but I have yet to look closely at that). In any case, as far as the science is concerned this would come in later with Modigliani and Friedman, etc.. Hayek initially did not make expectations as central as Keynes as far as I can tell, but he made up for that in his 1937 paper "Economics and Knowledge" which laid a lot of the groundwork for how to think about defining a dynamic equilibrium in terms of expectations. 

Much of this was not formalized until later - a point I'll come back to. In the early formalizations of all of these ideas in the 1930s and before of course you start out simple, perhaps not formalizing the more complicated ideas, and then build up. But that is very different from saying that nobody understood or thought about the role of expectations.

This is getting far afield of the Phillips Curve (of course there was no Phillips Curve per se at this point). However, even at the very beginning of work on the Phillips Curve people understood the importance of expectations and appreciated each other’s insights. Most notably, Leeson and Young (2008) report that Friedman actually got the equation for adaptive expectations from Phillips in 1952. He was fascinated by Phillips’s work (at this point, principally the machine although the Phillips Curve grew out of that) but understood that the implicit assumption of the model was an expectation of stability. Friedman asked Phillips how he would model expectations that were potentially unstable, and he produced the adaptive expectations equation that Cagan would make so famous in his analysis of hyperinflation (which, if you think about it, is just Friedman/Phelps with half a Phillips Curve!). The Cagan analysis would of course be adapted by the rational expectations revolution as well. So Friedman certainly was not under the impression that the early thinking on the Phillips Curve was done in ignorance of expectation augmentation. Interestingly enough, Friedman twice offered Phillips a job at the University of Chicago (which he twice turned down).

So even in these early years expectations were an important part of economics, the germ of later developments came from Phillips himself, and there was no sense that the scientific questions these men were probing were “peripheral”. What about Samuelson and Solow? 

2. The difference between Friedman/Phelps and Samuelson/Solow was a difference of (a.) formalism, and (b.) the natural rate hypothesis. It was not a disagreement about whether the Phillips Curve existed or whether it was stable. Everyone agreed that it did exist and it was not necessarily stable.

I really don’t need to overcomplicate this: If you think Samuelson and Solow (1960) said that the Phillips Curve offers a stable menu of trade-offs between inflation and unemployment there is an extraordinarily high probability that you simply have not read Samuelson and Solow (1960). Not reading them is OK in my opinion. I am not one of those people that think every single person should take history of economic thought. But by the same token if you’re going to make a claim about the article you should probably... I dunno… read the article?

Samuelson and Solow (1960) are actually principally concerned not with a menu of policy options (though that comes up) so much as with the fight going on at the time between cost-push, demand-pull and other lesser varieties of explanations of inflation. But they do come back to how to think about the Phillips Curve on page 193 where they (very famously) write:

“Aside from the usual warning that these are simply our best guesses we must give another caution. All of our discussion has been phrased in short-run terms, dealing with what might happen in the next few years. It would be wrong, though, to think that our Figure 2 menu that relates obtainable price and unemployment behavior will maintain its same shape in the longer run. What we do in a policy way during the next few years might cause it to shift in a definite way.

Thus, it is conceivable that after they had produced a low-pressure economy, the believers in demand-pull might be disappointed in the short run; i.e., prices might continue to rise even though unemployment was considerable. Nevertheless, it might be that the low-pressure demand would so act upon wage and other expectations as to shift the curve downward in the longer run-so that over a decade, the economy might enjoy higher employment with price stability than our present-day estimate would indicate.

But also the opposite is conceivable. A low-pressure economy might build up within itself over the years larger and larger amounts of structural unemployment (the reverse of what happened from 1941 to 1953 as a result of strong war and postwar demands). The result would be an upward shift of our menu of choice, with more and more unemployment being needed just to keep prices stable.

Since we have no conclusive or suggestive evidence on these conflicting issues, we shall not attempt to give judgment on them. Instead we venture the reminder that, in the years just ahead, the level of attained growth will be highly correlated with the degree of full employment and high-capacity output.”

Let’s take a tally of what is here and what isn’t here to better understand what was so important about Friedman and Phelps. First, Samuelson and Solow definitely don’t think the Phillip’s Curve offers a stable menu of policy options. They definitely recognize that it is a short-run trade-off. They also definitely recognize that policy choices impact the long run state of the Phillips Curve and they definitely recognize that expectations determine the long run state of the Phillips Curve.

What don’t Samuelson and Solow offer us? Well they don’t have a clear vertical long run Phillips Curve (i.e., they don’t have a natural rate). They have shifting curves in mind, which actually is what the data do end up looking like. If you read the rest of the article you’ll know that they also don’t have a model or any formal presentation of expectations. Part of the reason for this, of course, is that the whole point of their article is that the jury is still out on the theoretical underpinning of the Phillips Curve. We get both of these things from Phelps and Friedman, who set the ball rolling for modern macroeconomics: rational expectations, the Lucas critique, New Classical macro, New Keynesian macro, and what is sometimes called the “New Consensus” model.

The nature of adjustment depends of course on how expectations are formed, but the result of a NAIRU pops out as long as you assume that (1.) in the long run expectations have to conform to reality and (2.) full employment is determined by technical/exogenous factors. Phelps offers a more formalized picture than Friedman does and therefore has a more direct impact on later New Classical and New Keynesian Phillips Curves.

Some people, when discussing Samuelson and Solow on the stability of the Phillips Curve, like to point out that they thought that the curve shifted somewhat in the 1940s and 1950s or that differences in labor market institutions (principally unions) can explain some of the differences between the UK and the US. That’s all well and good but I think the passage above is what really drives the point home.

3. The contributions of Lucas were (a.) the introduction of much stronger assumptions about expectations and (b.) broader insights about the importance of using structural models.

Lucas comes at all this from a completely different angle because he’s interested in making a point about how we do modeling in macroeconomics. In the seminal Lucas island model, agents are assumed to be unaware of how much of the short run variation in their prices are due to general price level changes and how much is due to changes in the relative demand for their product. If they knew, they would not change their behavior in response to general price level changes but because they don’t know there is production (and therefore labor demand) response to price level changes: a Phillips Curve. The agents know the underlying probability distribution of all these components of the price and they have rational expectations, so in the long-run they can’t be fooled. There is, therefore, a slight difference in emphasis (though I wouldn’t say a fundamental difference) between Friedman’s argument and Lucas’s. In the island model the Phillips Curve comes from fooling people and you can’t fool people in the long run. In Friedman the Phillips Curve comes from more standard demand arguments and you can’t escape real factors in the long run. That’s a little stylized, but put in these terms it’s clear how Lucas is making much stronger assumptions about how agents interact with the world around them.

I’m sure Lucas was interested in inflation and unemployment, but the island model is extremely unrealistic (and when you read the paper it’s clear he knows that). So his real point, I think, isn’t to offer a convincing model of what’s going on so much as it is to point out that you can get the same reduced form relationship from a lot of different microfoundations and if you don’t know what microfoundations are true you can make policy decisions that can come back to bite you in the long run. This was a bit under the surface in his 1972 paper on the island model but it is front and center in his 1976 paper “Econometric Policy Evaluation: A Critique”. That paper is one of the most important in economics in the twentieth century. When I taught history of economic thought it was the only selection that I made my students (undergrads) read from for our single lesson on post-war short run macroeconomics (I had another lesson on growth theory). With Lucas I think you really get the whole path of post-war short run macro, from the Phillips Curve discussion through microfoundations, rational expectations, the rise of New Classical macroeconomics, and the structure of New Keynesian macroeconomics when it emerged. All of this pivots on Lucas.

But what didn’t Lucas say? Lucas definitely didn’t say there was no Phillips Curve or that it was “peripheral” (Magness’s words). It was quite real and like basically everyone before him he said that the short run and the long run versions were not the same thing. Friedman and Phelps brought formal expectations to the table and a NAIRU, while Lucas brought broader points about microfoundations and rational expectations assumptions to the table.

4. The Phillips Curve is extremely important. Essentially everyone uses it; it is not peripheral. There are active areas of research and disagreement over the Phillips Curve.

As with my Samuelson-Solow discussion, I’m not going to overcomplicate this: if you think the Phillips Curve is unimportant or peripheral to modern economics you’re simply wrong. Donald Kohn said that “A model in the Phillips Curve tradition remains at the core of how most academic researchers and policymakers – including me – think about fluctuations in inflation”. Although it’s important to remember there are a few steps to get from one to the other, the Phillips Curve is essentially just an aggregate supply curve, and the business cycle doesn’t really make sense without the aggregate supply curve. However, the fact that that’s settled doesn’t mean that there’s nothing interesting happening in the literature. I’m no expert in this area, but I think there are at least two important discussions going on.

First, it’s not entirely clear that the long run Phillips Curve is vertical. There’s good empirical evidence indicating that the long run Phillips Curve might be backward bending or otherwise downward sloping at low inflation levels. There are a variety of reasons offered for why this might be the case that are typically related to wage bargaining and rigidity or cognitive limitations around very low inflation levels (inflation is most costly to estimate and account for when it is high). This literature is generally associated with Palley in the Post-Keynesian world and Akerlof, Dickens, and Perry in the mainstream literature. Of course it has been of great interest lately with better anchored inflation expectations and subdued inflation during the Great Recession. This one is potentially huge because it does actually claim a (limited) long run trade-off.

The other, older discussion concerns “hysteresis” and whether the NAIRU is really stable. If the NAIRU is a function of past unemployment it could move around. Notice this is not just an observation that supply shocks could occur (which arguably is just a change in exogenous/technical factors and thus consistent with the original NAIRU idea). These are demand-side factors with a long-run impact on the NAIRU (albeit potentially through supply-side channels like skill degradation). This also has Post-Keynesian counterparts, and it is also of interest lately given the experience of persistent high unemployment.

None of this is “peripheral” stuff, I should add. Some of the biggest names in the field have wrestled with both of these questions, particularly the hysteresis issue.