__________________________________________________________________ Gabriel Philbois and Walter E . Block A Critique of the Phillips Curve – The Austrian Tradeoff 1 . Introduction Few ideas have been more influential in the economic policy of the last few decades than the tradeoff expressed in the Phillips Curve ( Phillips , 1958 ). 1 All over the world , central bankers base models and central plans on the idea that a “ national economy ” can trade inflation for unemployment , and vice versa . This is the belief behind the frequent increases in the money supply executed by governments . The dominant idea both in academia and among policy makers is that growth in liquidity should only be limited to the extent that it can cause untoward increases in the inflation rate , 2 while they 1 Wrote Oliver ( 1999 ): “ For more than 20 years , the Federal Reserve has seen its No . 1 job as balancing growth and inflation , a duty enshrined in the 1978 Full Employment and Balanced Budget Act . The theory behind this mission is that too much growth brings inflation , but slashing inflation too much would jack up unemployment . So the Fed ’ s job was to bring the Goldilocks economy : not too hot , not too cold , just right .” See also on this Salerno ( 2003 ), Ravier ( 2013 ), Casey ( 2014 ) and Tooley ( 2010 ). 2 The equilibrium between inflation and unemployment is assumed to be a natural consequence of democracy . Since both phenomena cause dissatisfaction among voters , polishould be used for reducing unemployment . In this paper we demonstrate that the tradeoff is more complex than it is generally believed to be , and that the cost of monetary policy is much higher than what policymakers advocate . The flaws of the theory behind the Phillips Curve and the many models that evolved from it abound . The underlying assumption of the existence of a “ national economy ” as a real being and not merely an abstract , heterogeneous and indefinable mental construct is problematic enough . There are also many issues with the assumptions behind employmentoriented monetary policy , such as the neutrality of money , the homogeneity of capital , and jobs as ends instead of means . Misconceptions about the true effects of deflation , and the pretense of knowledge in assuming macroeconomic ticians would have an incentive to not let any of them reach a level that is considered too high by the median voter . Gabriel Philbois is an economics major at the Joseph A . Butt , S . J . College of Business , Loyola University , New Orleans ( USA ). Walter E . Block is Harold E . Wirth Eminent Scholar Endowed Chair and Professor of Economics at the Joseph A . Butt , S . J . College of Business , Loyola University , New Orleans ( USA ). Laissez-Faire , No . 48-49 ( Marzo- Sept 2018 ): 35-48

__________________________________________________________________ calculation as a humanly feasible task reduce the possibility of rational decision making on the supposed tradeoff . In section 2 we deal with the national economy . The burden of section 3 is to discuss the Phillips curve and economic calculation . In section 4 we attempt to come to grips with the redistributive aspects of inflation . The subject of section 5 is the Hayekian triangle . Section 6 deals with the Austrian Business Cycle Theory , and section 7 with our attempt to ( partially ) defend the Philips Curve . We conclude in section 8 . seek profit . They do not hesitate to assign priority to the interests of the Volkswirtschaft over those of the individuals (...) The truth is that individuals in their acting , in their capacity as producers and consumers , as sellers and buyers , do not make any distinction as between the domestic market and the foreign market . They make a distinction as between local trade and trading with more distant places as far as the costs of transportation play a role . If government interference , such as tariffs , render international transactions more expensive , they take this fact into account in the same way in which they pay regard to shipping costs . 2 . The National Economy First of all , the idea of a “ national economy ” is problematic . Only individuals can act , and therefore the Volkswirtschaft is merely a mental construction , a figure of speech if you will . What matters in a plan is not the net effects on this mental construction , but those on each individual . A policy that will employ one man might bankrupt another . The monetary expansion that will bring prosperity to the bond dealer may impoverish a wage earner . Discussing net effects while ignoring the prices paid by individuals is the very negation of good economics . It undermines the confidence of investors , entrepreneurs and consumers . No serious argument can be made for a plan that aims for prosperity but trumps private property and individual rights , the very bases of economic development . As Mises ( 1949 , pp . 320-22 ) puts it : The Volkswirtschaft is a sovereign nation ’ s total complex of economic activities directed and controlled by the government (...) [ People often assume ] that there is an irreconcilable conflict between the interests of the Volkswirtschaft and Much more could be said about the incoherent proposition that a “ national economy ” -oriented central plan could be helpful for a market-based production system . Nevertheless , we will not focus on this issue in this paper , and we will demonstrate other problems with the Phillips Curve that become evident even if we , for the sake of argument , accept the idea of an existing “ national economy ”. 3 . The Phillips Curve and Economic Calculation When the government sets out to reduce unemployment , a very common course of action is to induce a credit expansion in the hopes of promoting spending , investment and , as a consequence , jobs . 3 How- 3 Other common policies include increasing government spending , subsidizing laborintensive industries , and creating tariffs ( see on this Block , 1976 , Chap . 23 ; Block , 2013 , Chap . 2 ; Block , Horton and Walker , 1998 ; Boudreaux , 2017 ; Brandly , 2002 ; Brown , 1987 ; Friedman and Friedman , 1997 ; Hazlitt , 1946 , Chap . 11 ; Johnsson , 2004 ; Landsburg , 2008 ; Mullen , 2015 ; Murphy , 2004 ; Ricardo , 1821 ; Roberts , 2016 ; Rothbard , 2005 ; Smith , those of the selfish individuals eager to 1776 ). All of these are failures on their own __________________________________________________________________ 36

__________________________________________________________________ ever , that is not the only easily observable effect of a credit expansion . As this new credit is not the result of increased savings , but instead a rise in the quantity of fiat money in circulation , the value of money will change . 4 The increase in supply causes a drop in the market value of money and a general rise in the prices of goods and services in the market . This reflects a boost in both consumption and investment , as real wages are lowered . Therefore , central bankers are assumed in effect to be able to create short-term employment , at the cost of inflation , by simply inducing the creation of fiat credit . The relationship between these two variables — inflation and unemployment — is represented in the Phillips Curve . Governments then proceed to pick certain points on this curve where they feel that inflation and unemployment are properly balanced . One problem with the unemployment merits , and we do not propose their use as alternatives to monetary policy . 4 The increase in the quantity of money does not necessarily involve its printing . Credit expansions through fractional reserve banking play an important role in monetary expansions . For a critique of fractional reserve banking see Bagus ( 2003 ), Bagus , Howden and Block ( 2013 ), Barnett and Block ( 2005 , 2008 , 2009 ), Baxendale ( 2010 ), Block ( 2008 ), Block and Caplan ( 2008 ), Block and Garschina ( 1996 ), Block and Humphries ( 2008 ), Block and Posner ( 2008 ), Davidson ( 2008 ), Davidson and Block ( 2011 ), Hanke ( 2008 ), Hazlitt ( 1979 ), Hollenbeck ( 2013 , 2014 ), Hoppe ( 1994 ), Hoppe , Hülsmann and Block ( 1998 ), Howden ( 2013 ), Huerta de Soto ( 1995 , 1998 , 2006 , 2010 ), Hülsmann ( 1996 , 2000 , 2002 , 2003 , 2008 ), Murphy ( 2010 ), North ( 2009 ), Polleit ( 2010 ), Reisman ( 1996 , 2009 ), Rothbard ( 1975 , 1990 , 1991 , 1993 ) and Salerno ( 2010a , 2010b , versus inflation tradeoff is that the latter cannot be adequately measured . So even if this were the only cost involved , no rational calculation would be possible . Any attempt to calculate the inflation resulting from monetary policy must be based on the variation of prices of a certain basket of goods , or specific sets of goods of those of a higher order . 5 For this method to be valid , two very unrealistic assumptions must be made : First , money must be considered neutral , otherwise variations of certain prices would not convey any information about the prices of other goods . Second , it must be assumed that in the absence of such policies there would be no deflation , or alternatively , it can be assumed that deflation is somehow harmful , and thus its prevention is not really a cost . 6 Neutrality is not a reasonable assumption because the increase in the quantity of money affects each individual and firm in a unique way . For instance , banks , which receive the new money first , are able to purchase goods at the pre-inflation levels , and thus benefit from a real increase in wealth . Wage earners , who only have their remuneration increased after a long delay , will have to buy goods at inflated prices while earning pre-inflation income , thus becoming poorer . Those on fixed incomes — the proverbial “ widows and orphans — are in even worse shape since their revenues never rise , but the prices they face most certainly do . Since 5 Garrison ( 2001 ) quite properly characterizes this as an “ earlier ” not a “ higher ” order . 6 On the actual economic benefits of deflation , see Bagus ( 2003 , 2006 , 2008a , 2008b ), Barnett and Block ( 2006 , 2008 ), Hulsmann ( 2008 ), Kaza ( 2006 ), Reisman ( 1996 , 2000 , 2003 , 2007 ), Rockwell ( 2003 ), Rothbard ( 1976 , 1991 ), Salerno ( 2003 , 2004 ) and Sel- 2011 ). gin ( 1997 ). __________________________________________________________________ 37

__________________________________________________________________ these effects are part of the production costs and impact both demand and supply of goods and services , they will lead to changes in relative prices and a different net price change for each good . 7 Therefore , any attempt to estimate a single inflation rate for the whole economy , and the very notion of general price level , are futile ( Mises , 1949 [ 1988 ]). As for the second problematic assumption , contrary to widespread belief , deflation is not only harmless , but it is also a natural and beneficial outcome of capitalism . It is harmless because it does not reduce investment , since entrepreneurs are not concerned with the nominal profits that are reduced by the falling prices . Entrepreneurs and acting men in general are properly concerned with real gains ( Higgs , 2008 ). Deflation is a natural outcome of capitalism , because there is a constant gain of productivity created by the accumulation of capital , which occurs in the form of technology , human capital , and physical capital . This means fewer resources are used in the production process , which creates the same amount of goods and services , or even more or them , and therefore they become cheaper . That is why free markets lead to an increase in wealth for all consumers , even those who did not increase their own productivity . While measuring the inflation created by their programs , central planners seem to completely ignore the fact that not only prices are rising , but also they should be falling and consumers should be getting wealthier because of this . Past experience show no incompatibility between deflation and growth , as Higgs ( 2008 ) explains : 7 A theory of monetary policy that assumes neutral money is as realistic and practical as a theory of airplane building that assumes no To elaborate just a bit , the rate of economic growth from 1866 to 1897 , a period of secular deflation , was perhaps the greatest ever experienced by the US economy during a period of comparable length . Real GDP grew by more than 4 per cent per year , on average , notwithstanding the persistent deflation . So , even if you ’ ve not mastered the works of Ludwig von Mises and Murray Rothbard , even if you are a confirmed positivist in your methodological bent ( as I was in 1971 ), you can see clearly that the rate of economic growth and the rate of pricelevel change have been independent , at least within the ranges of these variables in US economic history . This should be enough to end the argument about the Phillips curve . No person or organization can claim to be able to make rational decisions without having any real knowledge about the costs of the different alternatives . Besides , due to the redistributive effects of inflation , the question of the legitimacy of those acts also becomes pertinent , although ethics is not a subject addressed in the present paper . However , there is more to the Phillips Curve than the problems already mentioned , and its impact on the economy is much more complex than what has been discussed so far . 4 . Redistributive Aspects of Inflation We can , for instance , analyze the redistribution issue from the perspective of policymakers ’ goals . Creating employment is an agenda generally proposed with the declared intention of helping poor wage earners who depend on jobs to earn a living . In this case then , the redistributive effects of inflation are very relevant for the goals of the program . Jobs are means , not ends in themselves ; people work to acquire wealth and thus increase their gravity . __________________________________________________________________ 38