urjc – doctorado en economía aplicada (tesis doctoral) dynamic monetary theory and the phillips...

URJC – Doctorado en Economía Aplicada (Tesis doctoral)

DYNAMIC MONETARY THEORY AND THE PHILLIPS CURVE WITH A POSITIVE SLOPE

ADRIÁN RAVIER

[email protected]

Rosario, sábado 7 de agosto de 2010APPE International Conference, Maui, Hawaii, April 14-16, 2013.


Don Bellante and Roger W. Garrison (1988) compared two alternative approaches to monetary dynamics: those based on a vertical long-run Phillips Curve and those derived from analysis

of Hayekian triangles. The conclusion the authors reached is that the only factor differentiating the two models is the

“process” whereby the initial cause is converted into the final “neutral” effect. This article refutes that conclusion. To do so it

suffices to demonstrate that the long-term effect of monetary policy is never neutral. While it is true that after the boom-bust

cycle the economy returns to the natural rate of unemployment, the crucial point is that the ‘natural rate’ at the end of the cycle is quite different from the one evident at the start. This requires

an ‘Austrian’ Phillips Curve with a positive slope.


Abstract

Part I: The debate over the Phillips Curve.

Part I: The debate over the Phillips Curve.


Alban William Housego Phillips (1914-1975)

Source:

“The relation between

unemployment and the rate of

change of money wage rates in

the United Kingdom, 1861-

1957”

A. W. H. Phillips

(1958)



The Phillips Curve and the Economic Cycles

Source: “The relation between

unemployment and the rate of

change of money wage rates in

the United Kingdom, 1861-

1957” A. W. H. Phillips (1958)

“These conclusions are of

course tentative. There is

need for much more

detailed research into the

relations between

unemployment, wage rates,

prices and productivity”



The contribution of Paul Samuelson and

Robert Solow



The Keynesian Phillip`s Curve with a negative slopeELEMENTS

Short Run oriented approach

The stabilizaing effect of monetary

policy

The Non-Neutrality of Money in the

Short-Run

Implications for policymakers


A

0

UL U0 UH

Unemployment

Rate of Price Change

1 dpP dt


The refutation of the Phillips Curve

There were three events which were imposed against the hypothesis of Phillips´s trade off.

The first was represented by the general theoretical reaction against the Keynesian system,

both by the monetarists led by Milton Friedman, and also by the Austrian economists led by

Friedrich A. von Hayek.

The second was that the model, although well adapted for the study of Samuelson-Solow

(1960), failed in its application to other economies.

And third, the emergence of the process of "stagflation," understood as a phenomenon of

high inflation and high unemployment simultaneously.



Monetarist counter-revolution: Expectations-Adjusted Phillips Curve

ELEMENTS

Natural Rate of Unemployment

(NAIRU)

Monetary Policy short-run effects

(accepts the keynesian view)

Adaptive expectations

The lag in monetary policy. Clearly

distinguish the short-long run

effects.

Quantity Theory of Money and the

Principle of Neutrality of Money

M V = P y

Real Wages versus Nominal Wages

Acceleration of inflation theory

Implications for policymakers


B

A

UL UN

Unemployment

Rate of Inflation

1 dpP dt

H I

G

( 1 dp )** = B P dt

( 1 dp )* = A P dt

F

( 1 dp ) = 0 P dt

E

Part II: The Bellante-Garrison comparison

Part II: The Bellante-Garrison comparison


The Bellante-Garrison Comparison

In general, Monetarists have taken comfort in the Knightian

view that the structure of capital, particularly the inter-

temporal structure, can be safely ignored, and that theories in

the Austrian tradition, which make use of such concepts as

‘roundaboutness’ and ‘stages of production,’ are especially

misguided. (Bellante and Garrison, 1988: 208)



The Bellante-Garrison Comparison

Five points of commonality are noteworthy: (1) Both theories can be

fully squared with the kernel of truth in the quantity theory of money.

(2) Both theories deal with disequilibrium phenomena, but neither

denies that equilibrating forces dominate in the end. (3) Both hinge in

a critical way on the distinction between short-run effects and long-

run effects. (4) Both involve a market process that is necessarily, or

endogenously, self-reversing. Monetary disturbances cause certain

kinds of distortions in market signals. These distortions give rise in

the short run to movements in certain prices and quantities,

movements which in the long run create market conditions for

counter-movements in those same prices and quantities. (5) With

appropriate qualifications (about what constitutes the long-run) both

theories are characterized by monetary disturbances whose short-

run effects are non-neutral but whose long-run effects are neutral”

(emphasis added).


Part III: The positive slope of the Phillips curve

Part III: The positive slope of the Phillips curve


Milton Friedman: A positively sloped Phillips Curve?

“In recent years, higher inflation has often been accompanied by higher not lower

unemployment, especially for periods of several years in length. A simple statistical Phillips

curve for such periods seems to be positively sloped, not vertical.”

Milton Friedman (1976)

Francia Alemania I talia J apón Suecia Reino

Unido EE.UU.

Promedio

no

ponderado

DP M DP M DP M DP M DP M DP M DP M DP M

1956-

60

5.6 1.1 1.8 2.9 1.9 6.7 1.9 1.4 3.7 1.9 2.6 1.5 2.0 5.2 2.8 3.0

1961-

65

3.7 1.2 2.8 0.7 4.9 3.1 6.2 0.9 3.6 1.2 3.5 1.6 1.3 5.5 3.7 2.0

1966-

70

4.4 1.7 2.4 1.2 3.0 3.5 5.4 1.1 4.6 1.6 4.6 2.1 4.2 3.9 4.1 2.2

1971-

75

8.8 2.5 6.1 2.1 11.3 3.3 11.4 1.4 7.9 1.8 13.0 3.2 6.7 6.1 9.3 2.9

INFLATION AND UNEMPLOYMENT IN SEVENT COUNTRIES, 1956-1975. Note: DP is rate of change of consumer

prices compounded annually from calendar year 1955 to 1960; 1960 to 1965; 1965 to 1970; 1970 to 1975. M is

average unemployment during five indicated calendar years. As a result, DP is dated one-half year prior to

associated M.



A positively sloped Phillips Curve?

According to the five year

averages in the Table, the rate of

inflation and the level of

unemployment moved in opposite

directions-the expected simple

Phillips curve outcome – in five

out of seven countries between

the first two quinquennia (1956-60,

1961-65); in only four out of seven

countries between the second and

third quinquennia (1961-65 and

1966-70); and in only one out of

seven countries be-tween the final

two quinquennia (1966-70 and

1970-75).




The averages for all seven

countries plotted in Figure 3 bring

out even more clearly the shift

from a negatively sloped simple

Phillips curve to a positively

sloped one. The two curves move

in opposite directions between the

first two quinquennia; in the same

direction thereafter.




The third stage is directed at accommodating this apparent empirical

phenomenon. To do so, I suspect that it will have to include in the analysis

the interdependence of economic experience and political developments. It

will have to treat at least some political phenomena not as independent

variables - as exogenous variables in econometric jargon - but as

themselves determined by economic events – as endogenous variables [...].

The third stage will, I believe, be greatly influenced by a third major

development - the application of economic analysis to political behavior, a

field in which pioneering work has also been done by Stigler and Becker as

well as by Kenneth Arrow, Duncan Black, Anthony Downs, James

Buchanan, Gordon Tullock, and others. (Milton Friedman, 1977, p. 470)




In my doctoral thesis (Ravier, 2010), I called this “Friedman´s dilemma”

because Friedman observed an empirical reality his own analytical

framework was unable to explain. Friedman observes a positively sloped

Phillips curve and a long term effect of monetary stimulus which is not

neutral in real terms. Both are inconsistent with his own theories. Instead

he provides evidence confirming the work of Robert Lucas (1973) and, more

recently, William Niskanen (2002). Robert Mulligan (2011) has demonstrated

the connection between Niskanen’s article and Austrian Business Cycle

Theory.



Labor Market and “Natural” Unemployment


W/P

W/P*

Minimum Wage

D

S

QsQd

“Natural” Unemployment

Even though Milton Friedman developed this concept with Wicksell's “natural rate of interest” in mind, it is important to recognize that there is really nothing 'natural' about this special rate of unemployment. This ‘natural’ rate has several implicit precursors, such as labor legislation (especially the minimum wage), the monopoly power of unions, and efficiency wages, all of which represent rigidities in the labor market. In the absence of these labor market rigidities, full employment would be the true ‘natural’ rate.

This is the familiar textbook example showing the impact of a minimum wage set above the actual market wage, causing disequilibrium or unemployment. (Mankiw, 2001, p. 162) This is what Friedman calls ‘natural unemployment’, determined by local characteristics or other structural rigidities in the labor market.


Monetary Policy and Less Unemployment in the Short-Term


W/P

W/P*

Minimum Wage

D

S

QsQd

Less Unemployment

Qd’

D’

From this point, we consider the impact of expansive credit policy and its impact on the labor market following a sequence of steps consistent with Austrian Business Cycle Theory.

Unemployment is reduced, at least temporarily.


Capital Destruction and More Unemployment in the Long-Term


W/P

W/P*

Minimum Wage

D

S

QsQd

New Natural Unemployment

Qd’

D’

W/P**

It is at this point that the divergence of opinion occurs. Austrians explain that due to the mal-investment process during the stimulus phase we also face a situation in which the potential productive capacity of the economy is reduced as a consequence of the “partial destruction of capital”. That destruction inevitably occurs because there is a category of resources which are lost when investment projects are abandoned.


A Phillips Curve with a Positive Slope: A possible solution to Friedman´s Dilemma


Frictional Unemploy- ment

A

B C

ED

F G

U1 U2 U3 U4

0

2

3

1 Unemploy-ment rate

Inflation rate

Deflation rate

4

B*

Real Wage Rigidity and Structural Unemployment

U*

Accept the keynesian thesis in the short-run,

which we think is compatible with ABCT

Partially accept the monetarist theory in the

sense that the initial short run effect is

reversed in the long run.

However, we propose some differences, that

can be reduced to three debates:

1. The Non-Neutrality of Money in the

Long-Run

2. Subjective Expectations versus

adapative and rational expectations

3. The Austrian Business Cycle

Theory

CAPITAL THEORY

ConclusionsConclusions


A Phillips Curve with a Positive Slope: A possible solution to Friedman´s Dilemma



A

B C

ED

F G

U1 U2 U3 U4

1

2

3


Inflation rate

Deflation rate

4

B*


U*

Accept the keynesian thesis in the short-run,

which we think is compatible with ABCT

Partially accept the monetarist theory in the

sense that the initial short run effect is

reversed in the long run.

However, we propose some differences, that

can be reduced to three debates:

1. The Non-Neutrality of Money in the

Long-Run

2. Subjective Expectations versus

adapative and rational expectations

3. The Austrian Business Cycle

Theory

2001

2008

20016-17???

CAPITAL THEORY

URJC – Doctorado en Economía Aplicada (Tesis doctoral)Rosario, sábado 7 de agosto de 2010APPE International Conference, Maui, Hawaii, April 14-16, 2013.


A

B C

ED

F G

U1 U2 U3 U4

1

2

3


Inflation rate

Deflation rate

4

B*


U*

B

A

UL UN

Unemployment

Rate of Inflation

1 dpP dt

H I

G( 1 dp )** = B P dt

( 1 dp )* = A P dt

F

( 1 dp ) = 0 P dt

E

A

0UL U0 UH

Unemployment

Rate of Price Change

1 dpP dt

Thank you!Thank you!

urjc – doctorado en economía aplicada (tesis doctoral) dynamic monetary theory and the phillips...

Documents

appe international conference

austrian phillips curve

dp p dt slide

abstract slide

p dt e slide

policymakers rosario

rate of change

high unemployment