Grand Pursuit, Book Review Example

One of the main analytical “u turns” in recent economic history was over the relationship between employment and inflation- otherwise known as the ‘Phillips Curve.’ In the 1950s, William Phillips, an economist, wrote a paper examining the relationship between unemployment and price rises (inflation).  After a labored examination, Philips posited that an inverse relationship existed between the two variables: policy makers could decrease unemployment through allowing an increase in inflation; conversely, they could decrease inflation levels through allowing an increase in unemployment.  This relationship stayed (relatively) stable through the 1960s; however, the entrance to the 1970s, and the onset of stagflation (lower economic growth and economic growth) impugned the putative relationship between the variables.  Indeed, rather than a tradeoff, the relationship now saw in an increase in both variables as unemployment and inflation both skyrocketed.  Although there were subsequent attempts to mend the relationship,

Milton Friedman was one of the main critics of the Keynesian Philips Curve. He posited that “expectations” would ruin the tradeoff mechanism that Keynesians saw as a key to the tradeoff.  That is, if policymakers made the explicit decision to keep output above a certain level (the equilibrium), workers would have expectations of higher inflation and ratchet up their wage demands accordingly.  The “New Keynesian” school tried to put the curve back together including expectations as a main assumption in the model.

Irving Fischer’s One of the ideas I found most interesting in the book was Fischer’s idea of a debt-deflation based depression. Although Fischer initially developed this theory in the 1920s and 1930s, it still has profound implications for economics today.  For example, Japan has arguably been a debt-deflation cycle since a frothy real estate bubble broke in the 1990s.  After the bubble burst, both the government and central bank has tried to get the economy out of the deflation cycle through substantial fiscal stimulus and  the reduction of interest rates to near 0.  Even with these efforts, however, Japan is still in the cycle and has not experienced positive inflation in some time.  It will be interesting to see if Fischer’s theory is also applied to the developing economic situations in the US and Europe.

In thinking over the issues we studied this semester, I agree the most with Keynes’s approach to these issues.  In some senses, I am torn: I believe that Friedman/ Hayek provides a compelling framework to analyze these issues; however, at the end of the day I don’t believe it is  politically viable, particularly in the aftermath of the 2007 financial crisis to make the argument that the market will correct itself.  And even if the market would ultimately correct itself, without the help of government intervention,  I do not think the results would be politically palatable to the populace.

Thus, to appropriate a quote originally used by Richard Nixon: “We are all Keynesians now.” Although the macroeconomic environment in the 1970s differs from today, with major indecision in the private sector, the government is tapped as the main driver of future growth, as well as the arbitrar to redistribute income from the upper earners to the lower earners.  Indeed, some would posit that there is a market failure in the area of poverty that the government must fill.