Accommodation to Accommodationism: A NoteAuthor(s): Basil MooreSource: Journal of Post Keynesian Economics, Vol. 21, No. 1 (Autumn, 1998), pp. 175-178Published by: M.E. Sharpe, Inc.Stable URL: http://www.jstor.org/stable/4538621 .

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BASIL MOORE

Accommodation to accommodationism: a note

In a recent article in this journal, Palley (1996) argued that two principal differences divide what he calls the "accommodationist" and "structur- alist" approaches to endogenous money.

The first difference concerns "the treatment of the interaction between the policy authority's policy reaction function and the asset and liability management activities of banks" (Palley, 1996, p. 593). Palley asserts that accommodationists leave this interaction "unaddressed," and there- fore "fail to capture the feedback effects that link financial markets and monetary policy" (Palley, 1996, p. 585). Yet, as he immediately con- cedes in a footnote, if the accommodationist position is taken to refer only to the immediate current market period (as Moore, 1988, has explicitly argued), it is appropriate over such a short time horizon to regard the interest rate as set exogenously by the monetary authority, and the money supply function as horizontal.

Once it is recognized that the monetary authority sets interest rates exogenously only over the market period, this logically implies that no short- or long-run money supply relationship extending beyond the market period can be specified ex ante. In a nonergodic world, neither the economic analyst, nor the central bank can state today what the level of interest rates will be in the next period. (This is precisely what an "autonomous" policy instrument denotes.) For any particular policy reaction function, changes in the policy instrument will depend on changes in the authority's perception of the state of the economy, and on its perception of changes in the market's expectations of the state of the economy.

The authorities have total discretion as to when, and by how much, they adjust their instrument. In the United States, the "market period" would chronologically encompass the time between meetings of the Federal Reserve Open Market Committee-about five weeks-and the

The author is Professor of Economics at Wesleyan University, Middletown, Connect- icut, and at the University of Stellenbosch, Stellenbosch, South Africa.

Journal of Post Keynesian Economics / Fall 1998, Vol. 21, No. 1 175 c 1998 M.E. Sharpe, Inc.

01 60-3477 / 1998 $9.50 + 0.00.

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176 JOURNAL OF POST KEYNESIAN ECONOMICS

policy instrument would be the federal funds rate. The money supply function (reflecting the level of the chosen short-term interest rate instrument) can only be formulated for the current market period. Over this period, the money supply may be regarded as "horizontal."

Palley's model and his upward-sloping reserve supply function (Pal- ley, 1996, p. 590, fig. 2) can thus be seen to be invalid. As Palley himself states, the magnitude ofthe slope ofthe reserve supply function depends on the degree of central bank accommodation. Yet as evidenced by the historical behavior of short-term rates, there is no general necessity for interest rates to rise pari pasu with the level of bank lending. They may, and they frequently do, but they need not. It all depends. For example in the United States over the decade ofthe 1 980s, the base and the money supply rose substantially, while the level of short-term rates fell sub- stantially, albeit from a very high initial level.

Acceptance of the above also renders otiose Palley's second differ- ence, that for "structuralists" monetary policy is based on targeted adjustments of the quantity of reserves, as well as on changes in interest rates. There is no disagreement that by open market sales or purchases, the central bank at its discretion reduces or increases the quantity of bank nonborrowed reserves. But since banks' required reserves in any period are predetermined by past bank lending and deposit creation, changes in nonborrowed reserves necessarily cause identical changes in the opposite direction in free reserves (borrowed plus excess reserves), and so cause changes in the short-term interest rate. Interest rate targeting assures that the monetary base moves endogenously. The central bank continually injects or withdraws reserves in the process of keeping the short-term interest rate within its target band. The money supply and the monetary base thus become perfectly endogenous, determined by the quantity of bank credit demanded, at the interest rate set exogenously by the central bank.

The terminology "partial" or "complete" central bank accommodation, although widely used, should really be abandoned. It is a misleading (and confusing) relic of the mainstream vision that the central bank exogenously controls the money supply. In the real world, the central bank always fully accommodates bank demand for reserves, in its role as residual supplier of system liquidity. In a closed economy, it also must always set the level of short-term interest rates. Once the central bank has established reserve requirements, and set the short-term rate, the quantity of reserves it supplies becomes completely endogenous, and equal to the total quantity of reserves demanded by banks to support the

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A CCOMMODA TION TO A CCOMMODA TIONISM 177

quantity of loans they have made and deposits they have created. The central bank alters not the total but the composition of total reserves supplied, between borrowed and nonborrowed reserves, in the process of hitting its interest rate target. Given the level of reserve requirements and the interest rate target, the composition as well as the total quantity of reserves supplied become endogenous.

Palley is also mistaken that assessing whether a central bank reaction process is stable or optimal from a public welfare stance requires "specification of a complete structural macroeconomic model" (Palley, 1996, p. 593), as in Poole (1970). The behavior of a nonlinear and nonergodic world can neverbe precisely captured (accurately described, simulated, forecast) by any closed structural macroeconomic model, no matter how sophisticated. The future remains open and unknowable, so that the "optimality" of a policy can never be defined ex ante. No matter how complex or sophisticated our model, we can never forecast with precision where we are going. This is due not to the inadequacy of our models, but to the nonlinear nature of our universe. We can "create" our own futures but cannot "discover" them.

A Post Keynesian monetary policy does not require "the invention of a new macro model" (Palley, 1996, p. 593). In a democracy it requires primarily greater and wider public recognition and understanding of three very simple but deep Post Keynesian propositions:

1. Modern capitalist economies are ordinarily demand- rather than supply-constrained.

2. The level of interest rates is an exogenous policy instrument. Lower interest rates play a direct causal role in generating in- creases in market wealth values, perceived total subjective utility, the rate of deficit spending and nominal monetary growth, and the rate of expansion of aggregate demand.

3. The necessity for the establishment of a social contract to ensure that aggregate demand increases results in increases in real output. Otherwise, in the presence of market power, aggregate demand expansion soon results in higher prices being paid to rent-seeking factors, who find their market-power increasedparipasu as their "fear of the sack" is eroded.

In modern economies, inflation is largely the result of conflict over distributive shares. Because it has a "public goods" component, in the presence of market power inflation can be both unstable and self-per- petuating. In the absence of a social contract to restrain money wage

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178 JOURNAL OF POST KEYNESIAN ECONOMICS

increases to the rate of average labor productivity growth, so that unit labor costs remain constant, cost inflation due to conflict between business and labor can only be restrained by keeping the economy in semi-slump conditions. Currently the Federal Reserve, irrespective of the degree of excess capacity and unemployment in the system, raises interest rates at the slightest hint of oncoming inflation, in an attempt to preempt "inflationary" increases in aggregate demand.

REFERENCES

Moore, B.J. Horizontalist and Verticalists: The Macroeconomics of Credit Money. New York: Cambridge University Press, 1988.

Palley, T.I. "Accommodationism versus Structuralism: Time for an Accommoda- tion." Journal of Post Keynesian Economics, Summer 1996, 18 (4), 585-594.

Poole, W. "Optimal Choice of Monetary Policy Instrument in a Simple Stochastic Macro Model." Quarterly Journal of Economics, 1970, 84, 197-216.

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