Richard Lipsey has had an extraordinarily long and productive career as both an economic theorist and an empirical economist, making numerous important contributions in almost all branches of economics. (See, for example, the citation about Lipsey as a fellow of the Canadian Economics Association.) In addition, his many textbooks have been enormously influential in advocating that economists should strive to make their discipline empirically relevant by actually subjecting their theories to meaningful empirical tests in which refutation is a realistic possibility not just a sign that the researcher was insufficiently creative in theorizing or in performing the data analysis.
One of Lipsey’s most important early contributions was his 1960 paper on the Phillips Curve “The Relationship between Unemployment and the Rate of Change of Money Wages in the United Kingdom 1862-1957: A Further Analysis” in which he extended W A. Phillips’s original results, and he has continued to write about the Phillips Curve ever since. Lipsey, in line with his empiricist philosophical position, has consistently argued that a well-supported empirical relationship should not be dismissed simply because of a purely theoretical argument about how expectations are formed. In other words, the argument that adjustments in inflation expectations would cause the short-run Phillips curve relation captured by empirical estimates of the relationship between inflation and unemployment may well be valid (as was actually recognized early on by Samuelson and Solow in their famous paper suggesting that the Phillips Curve could be interpreted as a menu of alternative combinations of inflation and unemployment from which policy-makers could choose) in some general qualitative sense. But that does not mean that it had to be accepted as an undisputable axiom of economics that the long-run relationship between unemployment and inflation is necessarily vertical, as Friedman and Phelps and Lucas convinced most of the economics profession in the late 1960s and early 1970s.
A few months ago, Lipsey was kind enough to send me a draft of the paper that he presented at the annual meeting of the History of Economics Society; the paper is called “The Phillips Curve and the Tyranny of an Assumed Unique Macro Equilibrium.” Here is the abstract of the paper.
To make the argument that the behaviour of modern industrial economies since the 1990s is inconsistent with theories in which there is a unique ergodic macro equilibrium, the paper starts by reviewing both the early Keynesian theory in which there was no unique level of income to which the economy was inevitably drawn and the debate about the amount of demand pressure at which it was best of maintain the economy: high aggregate demand and some inflationary pressure or lower aggregate demand and a stable price level. It then covers the rise of the simple Phillips curve and its expectations-augmented version, which introduced into current macro theory a natural rate of unemployment (and its associated equilibrium level of national income). This rate was also a NAIRU, the only rate consistent with stable inflation. It is then argued that the current behaviour of many modern economies in which there is a credible policy to maintain a low and steady inflation rate is inconsistent with the existence of either a unique natural rate or a NAIRU but is consistent with evolutionary theory in which there is perpetual change driven by endogenous technological advance. Instead of a NAIRU evolutionary economies have a non-inflationary band of unemployment (a NAIBU) indicating a range of unemployment and income over with the inflation rate is stable. The paper concludes with the observation that the great pre-Phillips curve debates of the 1950s that assumed that there was a range within which the economy could be run with varying pressures of demand, and varying amounts of unemployment and inflationary pressure, were not as silly as they were made to seem when both Keynesian and New Classical economists accepted the assumption of a perfectly inelastic, long-run Phillips curve located at the unique equilibrium level of unemployment.
Back in January, I wrote a post about the Lucas Critique in which I pointed out that his “proof” that the Phillips Curve is vertical in his celebrated paper on econometric policy evaluation was no proof at all, but simply a very special example in which the only disequilibrium permitted in the model – a misperception of the future price level – would lead an econometrician to estimate a negatively sloped relation between inflation and employment even though under correct expectations of inflation the relationship would be vertical. Allowing for a wider range of behavioral responses, I suggested, might well change the relation between inflation and output even under correctly expected inflation. In his new paper, Lipsey correctly points out that Friedman and Phelps and Lucas, and subsequent New Classical and New Keynesian theoreticians, who have embraced the vertical Phillips Curve doctrine as an article of faith, are also assuming, based on essentially no evidence, that there is a unique macro equilibrium. But, there is very strong evidence to suggest that, in fact, any deviation from an initial equilibrium (or equilibrium time path) is likely to cause changes that, in and of themselves, cause a change in conditions that will propel the system toward a new and different equilibrium time path, rather than return to the time path the system had been moving along before it was disturbed. See my post of almost a year ago about a paper, “Does history matter?: Empirical analysis of evolutionary versus stationary equilibrium views of the economy,” by Carlaw and Lipsey.)
Lipsey concludes his paper with a quotation from his article “The Phillips Curve” published in the volume Famous Figures and Diagrams in Economics edited by Mark Blaug and Peter Lloyd.
Perhaps [then] Keynesians were too hasty in following the New Classical economists in accepting the view that follows from static [and all EWD] models that stable rates of wage and price inflation are poised on the razor’s edge of a unique NAIRU and its accompanying Y*. The alternative does not require a long term Phillips curve trade off, nor does it deny the possibility of accelerating inflations of the kind that have bedevilled many third world countries. It is merely states that industrialised economies with low expected inflation rates may be less precisely responsive than current theory assumes because they are subject to many lags and inertias, and are operating in an ever-changing and uncertain world of endogenous technological change, which has no unique long term static equilibrium. If so, the economy may not be similar to the smoothly functioning mechanical world of Newtonian mechanics but rather to the imperfectly evolving world of evolutionary biology. The Phillips relation then changes from being a precise curve to being a band within which various combinations of inflation and unemployment are possible but outside of which inflation tends to accelerate or decelerate. Perhaps then the great [pre-Phillips curve] debates of the 1940s and early 1950s that assumed that there was a range within which the economy could be run with varying pressures of demand, and varying amounts of unemployment and inflation[ary pressure], were not as silly as they were made to seem when both Keynesian and New Classical economists accepted the assumption of a perfectly inelastic, one-dimensional, long run Phillips curve located at a unique equilibrium Y* and NAIRU.”