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Caught in a hysteresis loop



November 02, 2010 – Comments (0)

Humility has never been Krugman's main character flaw, to put it very mildly, but in his last few blogs he allowed his arrogance to go supernova. 

This time the blog looks "scientific", featuring not one, but two graphs. The second one is a Philips curve. The first one is also a Philips curve, but turned 90 degrees. However, these are different Philips curves, displaying different data points. Both curves are meant to describe the same economy, confusing the hell out of the average reader.The mathematically sophisticated reader will surmise that Krugman must be talking about a hysteresis loop.

Krugman's scenario is one of the many possible ones, but it's hard to accept it as the ultimate truth carved in stone. My primary objection is, why does he want to start with inflation to get us to a point on the curve with low unemployment? Why not, for example, address unemployment first, and have employment set the rate of inflation? My second objection is, what makes Krugman think his two hypothetical curves are the right ones? Philips curves can take many different shapes. Make some changes in the underlying assumptions, and Krugman's Greap Leap Forward will easily get us into the hyperinflationary region of the diagram. 

 From a practical standpoint, there is little reason to believe inflation will reduce unemployment. There is no doubt it will give a boost to Krugman's personal balance sheet, but it's not obvious that much liquidity will trickle down. Empirical evidence suggests that QE simply rises the price of gold and invites people to gamble with risky stocks, which could actually produce more personal bankruptcies in the near future. And the fact is that productive activities still remain unprofitable in America because financial speculation is now the only practical way to preserve your wealth. But who wants to talk common sense when Krugman shows us diagrams?  

For some reason, Krugman's hysteresis loop in the Philips curve reminded me of Pfuel from "War and Peace": 

"Pfuel was evidently of that sort. He had a science- the theory of
oblique movements deduced by him from the history of Frederick the
Great's wars, and all he came across in the history of more recent
warfare seemed to him absurd and barbarous- monstrous collisions in
which so many blunders were committed by both sides that these wars
could not be called wars, they did not accord with the theory, and
therefore could not serve as material for science.

In 1806 Pfuel had been one of those responsible, for the plan of
campaign that ended in Jena and Auerstadt, but he did not see the
least proof of the fallibility of his theory in the disasters of
that war. On the contrary, the deviations made from his theory were,
in his opinion, the sole cause of the whole disaster, and with
characteristically gleeful sarcasm he would remark, "There, I said the
whole affair would go to the devil!" Pfuel was one of those
theoreticians who so love their theory that they lose sight of the
theory's object- its practical application. His love of theory made
him hate everything practical, and he would not listen to it. He was
even pleased by failures, for failures resulting from deviations in
practice from the theory only proved to him the accuracy of his
theory. "  

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