Phillips Curves Were Introduced in the 1960s as a “Deus ex machina” to Save the Orthodox-Keynesian Model

The ten years of 1966 to 1976 are labeled by Sinclair the “Decade of Disillusion.” The disillusion stemmed from the inability of the Orthodox-Keynesian model to explain what was going on in the world at that time. The most primitive Keynesian models assumed fixed prices; hence the models were inapplicable to questions about inflation except at full employment, anything beyond which the so-called classical model, involving a crude “Quantity Theory” of prices, held to be a “special case.” The introduction of the Phillips curve in the early sixties, at first as a deus ex machina, supposedly provided the missing link between the real sector and the price level. In time, Phillips-type phenomena were incorporated into the most sophisticated Keynesian-based econometric models, some of which ran into hundreds of equations. Even with the assistance of the Phillips curve, however, the existing varieties of Orthodox-Keynesian models were utterly inconsistent with the real-world phenomenon of stagflation, or more precisely, the breakdown of any apparently systematic, unidirectional movement between the level of economic activity and the rate of inflation. In truth, there were other difficulties that rendered Keynesian analysis inconsistent with the facts of the real world, but the incompatibility with stagflation was perhaps the key issue leading to the crisis for Keynesian orthodoxy and the demise of its mechanistic worldview.

—Don Bellante, “The Fork in the Keynesian Road: Post-Keynesians and Neo-Keynesians,” in Dissent on Keynes: A Critical Appraisal of Keynesian Economics, ed. Mark Skousen (New York: Praeger Publishers, 1992), 122.

Impossible or Not, the Aggregate Production Function Has Become a Mainstay of Mainstream Economics

The next decade (1956-66) is labeled by Sinclair the “Decade of Dynamics.” It was during this period that a fork clearly appeared in the road leading from Keynes, with one path eventually heading in the Post-Keynesian direction, the other in the Neo-Keynesian. Robert Solow’s (1956) so-called neoclassical growth model brought relative factor prices into play and gave a place to capital-labor substitution within a one-sector model. In significant contradistinction to Austrian capital theory, capital was treated as homogeneous, much as it was by Frank H. Knight. Knight, however, did not conceive of an aggregate production function, which in Austrian analysis is a logical impossibility. Impossible or not, the aggregate production function has become a mainstay of mainstream dynamic economics. There developed another strain of growth models in the Cambridge (England) tradition that forms the basis of Post-Keynesian dynamics. This strain includes the models of Nicholas Kaldor (1956) and others who share a common ancestry going back to Michael Kalecki (1937). Eschewing any role for substitution, these models are driven entirely by income effects, and they render determinate the distribution of income between the owners of capital and labor.

—Don Bellante, “The Fork in the Keynesian Road: Post-Keynesians and Neo-Keynesians,” in Dissent on Keynes: A Critical Appraisal of Keynesian Economics, ed. Mark Skousen (New York: Praeger Publishers, 1992), 121.