Stagflation

In the mid-70’s, economists were mystified by stagflation, the combination of stagnant production and rising prices. According to the Phillips Curve, the correlation of inflation with unemployment, stagflation should not happen.

… the U.S. economy was experiencing the phenomenon of ‘stagflation’ – a clearly discernible overturning of the conventional economic wisdom about the tradeoff between inflation and unemployment so neatly expressed in the Phillips curve. So-called ‘Keynesian fine tuning onto the neoclassical track’ was not working; and forms of socialist planning only promised to deepen rather than resolve the anomalies of welfare economics. … (Lonergan) believed he had an explanation for what, in a statement from the essay we are editing, he described as a “situation – sometimes thought mysterious – in which consumer prices continuously inflate, new enterprise is evaded, unemployment becomes chronic, and despite inflation the value of stocks declines.” [CWL 15, Editors Introduction, xli]

Economists could describe the phenomenon, but they could not explain it. Lonergan’s explanation – rather than a mere describing or non-explanatory postulating – is simply that stagflation boils down to, and is, an imbalance of the crossover flows between two circuits.  In Lonergan’s particular example the government’s disequilibrated taxation and spending constituted a discouraging draining of money from the surplus circuit accompanied by a flooding of money into the basic circuit. A stagflation doesn’t “result from” such a draining and flooding, rather it is” the draining and flooding. And as such, it is a deformation based in ignorance of how the economic process works.

We have claimed that the channels of Lonergan’s familiar Diagram of Rates of Flow explain inflation and deflation.  They provide a general, and thus universal, explanatory framework for analysis of the always-current, dynamic process.  The channels explain– rather than merely describe or postulate – both the dynamic equilibria of the pure cycle and the dynamic disequilibria of inflationary booms, deflationary slumps, and stagflation.  In the economic process basic and surplus incomes and expenditures can get out of normative, concomitant pace and balance.

More positively, the channels account for booms and slumps, for inflation and deflation, for changed rates of profit, for the attraction found in a favorable balance of trade, the relief given by deficit spending, and the variant provided by multinational corporations and their opposition to the welfare state. [CWL 15, 17]

New money for expansion should enter the economic process through (S” – s”O”) and (S’ – s’O’) rather than through (D” – s”I”) and (D’ – s’I’).

… positive or negative transfers to basic demand (D’-s”I’) and consequent similar transfers to surplus demand (D”-s”I”) belong to the theory of booms and slumps.  They involve changes in (aggregate basic or aggregate surplus) demand, with entrepreneurs receiving back more (or less) than they paid out in outlay (which includes profits of all kinds).  The immediate effect (of these aberrational monetary transfers) is on the price levels at the final markets, and to these changes (in price), enterprise as a whole responds to release an upward (or downward)  movement of the whole economy.  But the initial increased transfers to demand [that is, excess transfers along (D’-s’I’)  and (D”-s”I”) ] are not simply to be supposed.  For that would be postulating without explaining the boom or slump. [CWL 15, 64]

Postulating or describing without explaining is saying “This is what it looks like,” rather than “This is what it is,” or “This is the endogenous form of its explanation.”

(For greater perspective read also in CWL 15: Figures 24-6, Growth of Rate of Basic Production (Q’) over a Pure Cycle;  24-7, Rate of Change of dQ”/Q” and dQ’/Q’ over a Pure Cycle; and 27-1, Rate of change of v, w, and f during a Pure Cycle, Ideal Maximum f)

In a particular instance of stagflation, fellow flows are out of sync in magnitude or pace with one another. The stagflation may occur as a particular combination of any of several different elements which together would combine to constitute the stagflation. Here is a the Diagram of Rates of Flow annotated with some possible Elements of Stagflation.

Macroeconomic Field Theory is a set of invariant relations explaining the formal cause of the double-circuited macroeconomic process, just as electromagnetics is a set of invariant relations explaining the formal cause of the combination of electrical and magnetic phenomena.  Each case of stagflation ultimately boils down to, or can be explained as, an imbalance of the crossovers between the basic and the surplus circuits. Whether from a) disequilibrated taxation and spending, b) a sudden rise in oil prices and  reduced investment activity, or c) stimulus flows escaping intended channels, stagflation is a dynamic disequilibrium within a set of flows which should be interdependently coordinated with one another.  In CWL 15, 173-76, after sketching out a particular possible configuration of stagflation, Lonergan comments that, “what cannot be tolerated, much less sustained, is for one circuit to be drained by the other.” [CWL 15, 175]

Need the moral be repeated? There exist two distinct circuits, each with its own final market. The equilibrium of the economic process is conditioned by the balance of the two circuits: each must be allowed the possibility of continuity, of basic outlay yielding an equal basic income and surplus outlay yielding an equal surplus income, of basic and surplus income yielding equal basic and surplus expenditure, and of these grounding equivalent basic and surplus outlay. But what cannot be tolerated, much less sustained, is for one circuit to be drained by the other. [CWL 15, 175]

The Diagram of Rates of Flow represents the normative “fluid” circulations in the body-economic.  One can have insight into the Diagram; one can discern that the notions of concomitance (or proceeding together) and of credit (bridging the gap of time between payments made and payments received) combine to unify and time-telescope a unified, present, dynamic, organic whole; and thereby one reaches an understanding and explanation of a) the concomitances of particular flows, b) the conditions of continuity or keeping intracircuit and intercircuit pace, c) the presentizing of lags, and d) the normative equilibrium, which is systematically mandatory, among the dynamic, functional flows of the dynamic process.  In this insight all the concepts explaining the two-circuited process – interdependent, velocitous and accelerative flows solidary with one another in a system – tumble out together and one understands the entire organic process in a unified whole.

The economic process does not have the rigidity of Newton’s mechanics.  To be sure, there is an invariant set of relations.  There are norms of exchange which enlightened participants can honor freely, but which they can violate, and, by so doing, effect stresses, strains, and possible destruction of the economic organism.  The economic process is an organic whole which expands in a continuity comprised of a series of phases.  The nature of the process is such that the process must proceed only within the limits of equilibrium of these various phasesContinuity is the maintenance of organization within these limits. To step far enough outside them may bring about a general breakdown, i.e. it may “smash the organism”.

… it will be possible to distinguish stable and unstable combinations and sequences of rates in the three main areas and so gain some insight into the long-standing recurrence of crises in the modern expanding economy. [CWL 15, 53-54]

McShane – referring to Section 31,  Deficit Spending and Taxes – provides similar comments:

The other situation, with Z” less that T”, is one which seems more compatible with welfare tendencies. Surplus income , associated with the rich, is taxed more vigorously, while there is an easing of the tax burden on the less well-to-do. Z’ is then the prime outlet for government spending. Z” is small and overall surplus activity is discouraged. There is nothing surprising in a resulting consumer price-inflation, in a failure of enterprise, in a decline in both employment and stock value. [McShane, 2017, 95]

Superposed Deficit Spending and Taxes (CWL 15, 174)

2 Government Taxes and SpendingA superposed circuit 2, October 5, 18Insert 

The continuing economic process is, of its nature, a practically dynamic process and it always is the current process.  To analyze and explain practically continuous mechanical motion, one does not – as in the textbooks – take individual snapshots of a pendulum (oscillation) or a planet (ellipse) or a projectile (parabola) and explain what are continuous curves as a series of random, exogenous, efficient-causal shocks and resulting leaps of curves.  The force of gravity is not random nor is it, in modern field theory, exogenous.  Rather one abstracts from the empirical residue of individuality, particular times and places, and the non-systematic divergence of actual frequencies. One will use subscripts representing continuous time and one will seek differential equations explaining normative relations among interdependent velocities and accelerations.  One observes the practically-continuous motion, takes measurements, plots straight lines and curves of motion, discerns abstract patterns of interdependence indicating implicit definitions and relations, explores formalisms to find primary implicit equations of patterns and continuity which might possibly serve to define explanatory concepts implicitly, and one goes on to discern which of these are implicit equations whose explanatory-conjugate terms mutually define and condition one another and whose field-theoretic formulation a) is isomorphic with and explanatory of the  behavior of the phenomenon, b) explains the ideal process in the form of abstract conjugates implicitly related to and defining one another, and c) is universally relevant and applicable to the secondary, coincidental, concrete, boundary-value determinations occurring in a non-systematic manifold.  These boundary-value determinations occurring in a non-systematic manifold might be particular taxation changes, (oil) price changes, physical catastrophes, or pandemics.

One makes the creative key transition to explanation of the interrelated and linked velocities and accelerations by second-order terms.

Taking into account past and (expected) future values does not constitute the creative key transition to dynamics.  Those familiar with elementary statics and dynamics will appreciate the shift in thinking involved in passing from (static) equilibrium analysis … to an analysis where attention is focused on second-order differential equations, on d2θ/dt2, d2x/dt2, d2y/dt2, on the primary relativities of a range of related forces, central, friction, whatever.  Particular secondary boundary conditions, past and future pricings and quantities, are relatively insignificant for the analysis of the primary relativity immanent in, and applicable to, every instance of the process.  What is significant is the Leibnitz-Newtonian shift of context. [McShane, 1980, 127]

The Phillips Curve correlation is a staple of establishment, textbook economics.  Despite historical evidence to the contrary, it states that inflation and unemployment are strongly correlated and always a reliable guideline for interpretation of excess inflation or unemployment so as to choose corrective policy.  The interpreters suppose that when activity relative to capacity is robust, and units of enterprise have strong backlogs and pricing power, inflation is high and unemployment is low.  Conversely, when activity relative to capacity is weak and units of enterprise have diminished backlogs and lack pricing power, unemployment is high.  The Phillips Curve is insufficiently nuanced and misses the implications of two interrelated circuits and of an economic expansion in phases which have shifting magnitudes and velocities; and the Phillips Curve nonchalantly assumes an easy achievement of a sweet spot of meager inflation and full employment.  But the Phillips Curve assumption is not an economic law.

Stagflation happens, as it did in the late 1970’s when the high price of imported oil inflated both corporate costs and consumer expenditures for gasoline in the basic circuit, while discouraging and stagnating the investment constituting surplus activity.  While the change in oil prices may be described as a random, exogenous “shock,” it remains that a) the economic process remains a dynamic process, b) the field-theory of the macroeconomic process remans the same set of invariant primary relativities, and c) prices – such as oil prices – are secondary determinations from the non-systematic manifold to which the primary relationships are applied.  Thus, instead of speaking of external shocks and quantum leaps of curves, in another context we spoke of dynamic stresses and strains among flows of products and payments.

While we can effect the anti-egalitarian shift with some measure of success, in fact the egalitarian shift (required for the basic expansion) is achieved only through the contractions, the liquidations, the blind stresses and strainsof a prolonged depression. (CWL 15, 153-54)

We repeat the Diagram of Rates of Flow annotated with elements which may combine to constitute stagflation.  The cause in the double-circuited system is not always either disequilibrated government taxation and spending between the two circuits, or supply shocks.  The Phillips Curve’s occasional or usual agreement with facts is not by any means an economic law.  However, an imbalance of crossover payments between the basic and surplus circuits is ultimately the fundamental form of stagflation.

 

Addenda:

The ideal of constant exchange value:

the dummy must be constant in exchange value, so that equal quantities continue to exchange, in the general case, for equal quantities of goods and services.  The alternative to constant value in the dummy is the alternative of inflation and deflation.  Of these famous twins, inflation swindles those with cash to enrich those with property or debts, while deflation swindles those with property or debts to enrich those with cash; in addition to the swindle each of these twins has his own way of torturing the dynamic flows; deflation gives producers a steady stream of losses; inflation yields a steady stream of gains to give production a drug-like stimulus. [CWL 21, 37-38]

An initial and provisional theorem of continuity was enounced in a preceding chapter (§24).  Now it may be indicated in its full generality. ¶ The analysis has revealed that the economic system is a pattern of aggregate dynamic relationships arranged in different kinds of velocity and accelerator rhythms. In the real order there are the primary and secondary rhythms, with the former accelerated by the latter.  In the monetary order there are the rhythms of excess release from the redistributional area to the primary and secondary rhythms; and again, the former accelerate the latter. ¶ Now the general theorem of continuity is that this complex machine has a nature that must be respected.  Absolutely, there is no necessarily right value for the monetary accelerators DT’, DT”, DC’, DC”; again, absolutely, there is no necessarily right values for the six multipliers C’, C”, T’, T”, G’, G”.  But what is true is this: as soon as a few of these are determined, the rest become determined within narrower limits, for all form part of an organic whole; to violate this organic interconnection is simply to smash the organism, to create the paradoxical situation of starvation in the midst of plenty, of workers eager for work and capable of finding none, of investors looking for opportunities to invest and being given no outlet, and of everyone’s inability to do what he wishes to do being the cause of everyone’s inability to remedy the situation.  Such is disorganization.  Continuity, on the other hand, is the maintenance of organization, the stability of the sets and patterns of dynamic relationships that constitute economic well-being in a society. ¶ While the provisional theorem of continuity (§24) did regard the static phase, it is important to observe that the general theorem regards any phase.  There is a general historical movement of ideas, opportunities, and decisions integrating into that major rhythm in which transformations are followed by exploitations only to bring forth new and deeper transformations.  Within this broad historical scheme of things, the role of any age, and still more of any country, is but a small thing: the past was settled by our forebears, and the future will be in the hands of posterity; only the present is ours, and it is only within the limits that we make of the present what we wish.  Our starting pint is already determinate: we have to face things as they are; we may never lose sight of them or attempt to reckon without them.  But not only is there ever a broad and unalterable datum of things as they are; there are also the limitations which this datum imposes on things as we are going to make them.  ¶ The theorem of continuity is the abstract and formal aspect of such limitations in the economic order.  At the moment the exchange process is static or expanding or contracting.  We may like it so or we may wish it different.  But in any case there is some determinate range of values of the multipliers and of the monetary accelerators – of C’, C”, T’, T”, G’, G”, of DC’, DC”, DT’, DT” – that corresponds with such a decision.  Moreover there has to be an internal coherence between these values, and to violate this coherence is to rout economic organization.  Just as the movements of the controls of an airplane must be coordinated and all coordinations are not possible at all instants, so also he economic machine as its controls, which can be moved only in concert and only in a limited number of ways at any given time.  ¶ Such is the general theorem of continuity.  In the abstract and in a general way, it affirms that the economic process can proceed only within the limits of equilibrium of the various phases.  To step outside them is to bring about a general breakdown. (CWL 21 73-5)

Functional Macroeconomic Dynamics is a field theory of dynamic continuity and equilibrium.  The Normative Pure Cycle of Expansion stands in contrast and in opposition to the trade cycle of boom and systematically-necessary corrective slump.  The pure cycle is an ideal and general conception.  It is a normative theory and framework wherein a) flows in a circular conditioning within a circuit keep pace, b) crossovers flows in a crossover conditioning between circuits balance, c) money is supplied to the supply functions by the issuing authorities in proper proportion to the values of the expanded transactions, d) velocities and accelerations of expansionary investments in the surplus expansion are properly constrained, e) the basic expansion is implemented subsequent to the surplus expansion, f) money needed for the operations in the operative circuits or for prudent reserves for catastrophe and retirement is not drained into idleness in the Redistributive Function, f) government receipts and expenditures are balanced so as to avoid inflation which swindles those with cash to enrich those with property or debts, and deflation which swindles those with property or debts to enrich those with cash, and thus f) the full potentials of production and employment are achieved.