Transcript The New View On Monetary Policy: The New Consensus And Its

The New View On
Monetary Policy: The
New Consensus And Its
Post-Keynesian Critique
Peter Kriesler and Marc
Lavoie
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The New View On Monetary
Policy: The New Consensus And
Its Post-Keynesian Critique
 Introduction
 The
New Consensus: the
underlying framework
 Some critiques:
i: The IS Curve
ii: The Phillips Curve
 Modifications to the Phillips
curve
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THE NEW CONSENSUS
 Underlying
view of the economy
the same as Monetarism Mark 1
 Upwards sloping short run
Phillips curve with the long run
Phillips curve being vertical at
NAIRU
 ∆π = ß1 (u – un)
(1)
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The New Consensus
 “There
is substantial evidence
demonstrating that there is no long-run
trade-off between the level of inflation
and the level of unused resources in
the economy – whether measured by
the unemployment rate, the capacity
utilization rate, or the deviation of real
GDP from potential GDP. Monetary
policy is thus neutral in the long run.
An increase in money growth will have
no long-run impact on the
unemployment rate; it will only result
in increased inflation.” Taylor 1999
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Phillips Curve
 The
inflation rate falls when
unemployment is above NAIRU, and
increases when unemployment is
below it.
 In other words, there is a short run
trade-off between inflation and
unemployment, but no long-term
trade-off.
Inflation Rate
Neoclassical Long Run Philips Curve
.
P
2
.
P1
SRPC2
SRPC1
O
NAIRU
Unemployment rate
IS Schedule
 Assumes
that investment, or more
precisely, the growth rate of capital,
is inversely responsive to changes in
the rate of interest  linear
relationship between the rate of
interest and the level of output, and
hence unemployment  high degree
of interest elasticity of investment
 u = u0  ß4 r
(2)
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Monetary Rule, or what is really
new!
 Interest
rates should be changed if
inflation deviated from its target or
if real GDP deviates from potential
GDP
 No longer any attempt to control
monetary aggregates
 ∆r = β7 (π – πT) + β8 (u – un)
(3)
πT = target inflation rate
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Some critiques: IS Curve
Reject the simple interest rate investment relation implied in the
IS model:
 Central bank sets short term
interest rate, but it is long term
rate which influences aggregate
demand, and relation unclear
 Monetary policy is a blunt
instrument, with long and variable
lags.
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Some post-Keynesian critiques:
Efficacy of Monetary Policy



Real interest rate hikes lead to higher
inflation rates, through interest cost
push.
Post Keynesians reject the neutrality of
money in the short and the long run⇒
monetary variables have real effects.
Empirically, evidence suggests that the
interest elasticity of investment is nonlinear and asymmetric.
Interest rates ↑ → investment ↓ in times
of economic booms, the reverse is not
true.
Interest rates ↓ → unlikely investment ↑
in times of recession.
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INTEREST ELASTICITY OF
•
•
INVESTMENT
You can lead a horse to
water but you can’t make
it drink.
Many economists think
that using monetary
policy in a recession is
like pushing on string.
Some post-Keynesian critiques: The
Phillips Curve


Post-Keynesians reject the vertical longrun Phillips curve, and some are
skeptical about short-run trade-offs
between GDP/capacity and inflation.
Post-Keynesians reject the notion of a
supply-determined natural growth rate.
If the concept of a natural growth rate is
to be of any assistance, it is determined
by the path taken by the actual growth
rate.
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Kaldor: The Scourge of Monetarism
Assuming that the behaviour of the `real'
economy is neutral with respect to
monetary disturbances, why should the
elimination of inflation be such an
important objective as to be given 'overriding priority'? In what way is a
community better off with constant prices
than with constantly rising (or falling)
prices? The answer evidently must be that
… inflation causes serious distortions and
leads to a deterioration in economic
performance, etc. In that case, however,
the basic proposition that the `real'
economy is impervious to such
disturbances is untenable. Pp. 41-42
Critique of the Phillips curve
 Kaldor/Lavoie:
why is low inflation
good? ⇒ optimal inflation rate which
maximises the economy’s natural
growth rate ⇒ the natural growth
rate is determined by the path of the
actual growth rate ⇒ vital role for
effective demand. Model is path
determined.
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post-Keynesian modifications to
the Phillips curve
Setterfield: demand-type considerations
are not the only influence on the inflation
rate. Cost considerations, as well as
institutional variables are important.
Modified Phillips curve →multiplicity of
possible long-run rates of growth, capacity
utilization and inflation
 π = β9 π-1 + β10 u + πc
(1A)
π c “is a vector of institutional variables
that affect aggregate wage and price
setting behaviour”

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The Kriesler/Lavoie Phillips Curve
Inflation rate
ufc : full capacity
utilization
πn : rate of inflation
associated with the
normal range of output
πn
um
Ufc
Rate of capacity
utilization
Post-Keynesian Phillips Curve
The Kriesler/Lavoie Phillips Curve
π
= ß11 (u – um) + ß12 (u – ufc) + πn
 For
a large range of capacity
utilization u such that um < u < ufc ,
 ∆π = 0
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The Kriesler/Lavoie Phillips
Curve
Over normal range, changes in
capacity and employment have no
effect on inflation rate ⇒ both
monetary policy and fiscal policy will
influence output and employment in
both the short and long run
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