Transcript g - University of Ottawa

A post-Keynesian alternative to the New
consensus on monetary policy
Marc Lavoie
University of Ottawa
What is the New consensus?
• New Keynesian “consensus-type model”,
where policy reaction functions are “an
essential part of the macroeconomic
system”.
• Also called, the New Keynesian Synthesis
• J.B. Taylor, Blinder, D. Romer, Woodford,
Meyer.
How is the New consensus linked to
post-Keynesian theory?
• Positively
• Negatively
• “The main change is
• The New consensus
that it replaces the
reproduces accepted
assumption that the
dogma among
central bank targets the
neoclassical economists,
money supply with an
la pensée unique as the
assumption that it
French say.
follows a simple interest
rate rule” (Romer 2000:
154).
How is the New consensus linked to
post-Keynesian theory ?
(2) About the reaction function
• Post-Keynesians
• There is an interest
rate reaction function
because it cannot be
otherwise. Money
supply targeting is
impossible in principle
and in practice.
• New Consensus
• There is an interest
rate reaction function
because interest rate
targeting is more
successful to dampen
shocks to money
demand than money
supply targeting.
La pensée unique
• Expansionary fiscal policy only leads to
higher inflation rates and higher real interest
rates in the long run;
• More restrictive monetary policy only leads
to lower inflation rates in the long run.
The new consensus: summary
• The new consensus is simply a variant of
monetarism;
• but without any causal role for money.
• It is monetarism without money.
New consensus model
•
•
•
•
•
•
IS function:
g = g0 ! $r + ,1
Vertical Phillips curve
dB/dt = ((g ! gn) + ,2
Central bank reaction function:
r = r0 + "1(B ! BT) + "2(g ! gne)
New consensus model:
An alternative version (Setterfield)
•
•
•
•
•
•
IS function:
g = g0 ! $r + ,1
Vertical Phillips curve
dB/dt = ((g ! gn) + ,2
Central bank reaction function:
dr = "1(B ! BT) + "2(g ! gne)
Implicit to
the New Keynesian model
• A natural real interest rate
• r0 = rn = (g0 ! gn)/ $
• which implies (g ! gn) = $(r – rn)
• A natural growth rate, given by supply-side factors
• gn = a constant
Figure 5: The hidden consensus equation
B
0
gn
gn
2000 survey of AEA economists
• Question: Real GDP eventually returns
automatically to potential real GDP?
– Agree: 63 %
– Disagree: 37 %
– Journal of Economic Education, Fall 2003
2000 survey of AEA economists
• Question: There is a natural rate of
unemployment to which the economy tends
in the long run ?
– Agree: 68 %
– Disagree: 32 %
r
Figure 1: The graphical new consensus with
T)
r
=
r
+
"
(B
!
B
0
1
r
RF


MP
IS
B
B
g
B


AD
B
Start with the historically given rate of inflation
gn
g
r
r with rising MP curve
Figure 2: New consensus
RF
MP


IS
B
B
B

g

AD
B
gn
g
r
Figure 3A: Impact of a rise in effective demand:
r
RF
There is a lag in inflation
r3
r1
B
A

MP

IS
B
B
g
B
B3
B1


B
A
IA
AD
B
gn
g2
g
Figure 3: Impact of a rise in effective demand
r
r
r3
RF
r1
C
A

B


MP
IS
B
B
g
B
B3
B1


C

B
A
IA
AD
B
g3=gn g2
g
Figure 4A: Bringing back inflation to its target rate
r

RF4

r4
r3
D
C

r1

B


MP
A
IS2
RF1
IS1
B
B
B
B3
g
D

BT
B

A
g4
C

gn

B
g2
IA
AD2
AD1 AD4
g
Figure 4: Bringing back inflation to its target rate
D
r

RF4

r4
r3
D
C

r1

B


MP
A
IS2
RF1
IS1
B
B
B
B3
g
D

BT
B

A
g4
C

gn

B
g2
IA
AD2
AD1 AD4
g
Post-Keynesian alternatives
• (1): Reject the vertical Phillips curve and
replace it with a long-run downwardsloping Phillips curve (Setterfield)
• Or,
• (2) Endogenize the natural rate of growth gn
(Lavoie)
Similarity with PK critique of
natural rate of unemployment
• Hargreaves-Heap (Economic Journal 1980)
• Cottrell (JPKE, 1984-85)
• dUn /dt = N(U ! Un) + ,3
Post-Keynesian views
• “Disequilibrium adjustment paths can affect
equilibrium outcomes” (Colander, 1996:
60), leading to multiple equilibria and to
path-dependent equilibria.
• “The natural rate of growth is ultimately
endogenous to the demand-determined
actual rate of growth” (Setterfield, 2002: 5)
Post-Keynesian views II
• “Neoclassical growth economists on the one
hand, ... treat the rate of growth of the
labour force and labour productivity as
exogenous to the actual rate of growth....
• Economists in the Keynesian/postKeynesian tradition, ... maintain that growth
is primarily demand driven because labour
force and productivity growth respond to
demand growth” (León-Lesdema and
Thirlwall, 2002).
2000 survey of AEA economists
• Question: Changes in aggregate demand
affect real GDP in the short run but not in
the long run ?
– Agree: 62 %
(potential growth is given)
– Disagree: 38 % (potential growth is affected
by short-run effective demand)
The alternative PK model
g = g0 ! $r + ,1
dB/dt = ((g ! gn) + ,2
r = r0 + "1(B ! BT) + "2(g ! gn)
r0 = rnT = (g0 ! gn)/ $
dgn /dt = N(g ! gn) + ,3
PK model becomes a system of two
differential equations
 dg / dt 
 dg / dt 
 n


  (1   2  )   1 

1   2



  (1   2  )   1 
1   2





  3   2  (d 1 / dt ) 
g  

1   2
g   

 n 
3


PK model becomes a system of
two differential equations
• The dynamics of this system are pretty
straightforward, because the determinant of
this system is zero;
• and because its trace, is always negative.
• The amended new consensus model
displays a continuum of equilibria. The
model is said to contain a zero root.
• As the long-run equilibrium is not
predetermined anymore, the steady-state
rate of accumulation now depends on
transitional dynamics, which cannot be
ignored: short-run events have a qualitative
impact on long-run equilibria. It is common
to speak of ‘path-dependence’ for such a
characteristic. It is possible to show that this
kind of model displays hysteresis in the
sense of a ‘permanent effect of a transitory
shock’ (Olivier 1999).
An example of hysteresis
• For instance, a temporary increase in the
rate of price inflation that would arise
independently of excess demand pressure
would have permanent effects on the natural
rate of growth and the natural real rate of
interest.
Another example
• Monetary policy now has real effects that
go beyond its impact on the inflation rate.
• Zero-inflation or low-inflation targeting has
a negative impact on the real economy,
bringing in high real rates of interest and
low real rates of growth.
Figure 6: Path-dependence, likely case
gn
dg = 0
dgn = 0
A*
gn
B

E


A
B*
gB gnB gnE gnA gA
g
Figure 8A: Reducing the inflation target: PK model
r
rB
rB *
r
RF2


B

C

rC
rE


E
IS
B
B
g
B
BE

B
BC
AD2

BT
B

E
C
AD

gB
gnC gnE
g
Figure 8: Reducing the inflation target: PK model
r
r
rB
rB *
RF3
RF2



B

B*

C

rC
rE


E
IS
B
B
g
B
BE


B
BC
BT
B


C
E
AD
B*
gB gnB gnC gnE g