The New View On Monetary Policy: The New Consensus And Its PostKeynesian Critique

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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
• ?p 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.

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Neoclassical Long Run Philips Curve
. P2
Inflation Rate
. P1
SRPC2
SRPC1
O
NAIRU
Unemployment rate
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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 ß7 (p pT) ß8 (u un) (3)
• pT 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 non-linear 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 cant make
  it drink.
• Many economists think that using monetary policy
  in a recession is like pushing on string.

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Some post-Keynesian critiques The Phillips Curve

• Post-Keynesians reject the vertical long-run
  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
  'over-riding 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

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Critique of the Phillips curve

• Kaldor/Lavoie why is low inflation good? ?
  optimal inflation rate which maximises the
  economys 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
• p ß9 p-1 ß10 u pc (1A)
• p c is a vector of institutional variables
  that affect aggregate wage and price setting
  behaviour

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The Kriesler/Lavoie Phillips Curve
ufc full capacity utilization pn rate of
inflation associated with the normal range of
output
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The Kriesler/Lavoie Phillips Curve

• p ß11 (u um) ß12 (u ufc) pn
• For a large range of capacity utilization u such
  that um lt u lt ufc , ? ?p 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