Showing papers on "Inflation published in 1972"

The Second Crisis of Economic Theory

Abstract: This chapter discusses the second crisis of economic theory. It is related to the first crisis—the great slump of the thirties. The first crisis arose from the break­down of a theory that could not account for the level of employment. The second crisis arose from a theory that could not account for the content of employment. The second crisis links up with the first. The first crisis failed to be resolved because there was no solution to the problem of maintaining near-full employment without inflation. The experience of inflation has destroyed the conventions governing the acceptance of existing distribution. Income from property is not a reward of waiting but a reward of employing a good stock broker. There is also the problem of the relative levels of different types of earned income. The chapter also discusses the marginal productivity theory.

Macroeconomic Theory and Policy

Abstract: I. AN INTRODUCTION TO MACROECONOMICS. 1. Actual and Potential GNP: Fluctuations and Growth. 2. A Review of the National Income and Product Accounts. 3. Introduction to Income Determination: The Multiplier. II. NATIONAL INCOME DETERMINATION: THE STATIC EQUILIBRIUM MODEL. 4. Demand-Side Equilibrium: Income and the Interest Rate. 5. An Introduction to Monetary and Fiscal Policy. 6. Demand and Supply in the Labor Market. 7. Supply-Side Equilibrium: Output and the Price Level. 8. Equilibrium in the Static Model. 9. Monetary, Fiscal, and Incomes Policy. 10. Search, Wage Rigidity, and Unemployment. 11. Rational Expectations and Demand Policy. III. SECTORAL DEMAND FUNCTIONS AND EXTENSIONS OF THE STATIC MODEL. 12. Consumption and Consumer Expenditure. 13. Investment Demand. 14. The Demand for Money. 15. The Supply of Money. 16. Monetary and Fiscal Policy in the Extended Model. 17. The Foreign Sector and the Balance of Payments. 18. Macroeconomics When Markets Do Not Clear. IV. MEDIUM-TERM DYNAMICS: BETWEEN STATIC EQUILIBRIUM AND LONG-RUN GROWTH. 19. Inflation, Productivity, and Income Distribution. 20. Inflation and Unemployment: The Phillips Curve. 21. Introduction to Stock-Adjustment Dynamics. 22. Trend Growth in the Static Model. V. LONG-RUN GROWTH WITH FULL EMPLOYMENT. 23. Introduction to Growth Models. 24. The Basic Neoclassical Growth Model. 25. The Basic Model Extended: Varying Saving Assumptions. 26. The Golden Rule and an Introduction to Optimal Growth Models. 27. Medium-Term Growth and "The Measure of Our Ignorance."

Wage-Price Controls and the Shifting Phillips Curve

Abstract: THE CONDITION OF THE U.S. ECONOMY improved in almost every respect after the initiation of the wage-price control program on August 15, 1971. Real gross national product grew rapidly, unemployment finally began to decline, and the rate of inflation moderated. But the coincidence of timing does not necessarily mean that controls are an essential condition for prosperity, or that the August 1971 message was the key that unlocked the floodgates behind which real aggregate demand had been restrained. The major task of this paper is to assess the effect of the controls by comparing the actual performance of the economy with its performance without controls as predicted by an econometric model fitted to the precontrol period. Since the reliability of econometric inflation equations is subject to doubt in light of their inaccurate predictions in the late 1960s, a substantial portion of the paper is devoted to an assessment of the stability of the coefficients in several recently published wage equations. The determination of the four basic macroeconomic magnitudes-nominal (current dollar) income, real output, prices, and unemployment-is usefully separated into three subproblems: (1) the determination of nominal income, (2) the division of that nominal income between real output and prices, and (3) the relationship between real output and unemployment. This paper concentrates on the second problem and assumes that nominal income is determined independently of the control program by past and

Inflation and the Consumer

Abstract: THE STUDY BY F. Thomas Juster and Paul Wachtel in an earlier issue of Brookings Papers on Economic Activity' provides a most useful confirmation of considerations about consumers' reactions to inflation presented by this writer over many years. Juster and Wachtel make extensive use of data collected by the Survey Research Center's quarterly surveys of changes in consumer attitudes and expectations. The appendix to the article presents two tables on data used, both of which contain adjusted data. The discussion of the paper indicates that the readers have received a misleading impression about survey findings during the last few years. Therefore, some of the original survey data are reproduced in this communication. Table B-2 (page 112) presents the changes in the center's index of consumer sentiment as "filtered" by Juster, who introduced a considerable lag. The unadjusted index, as presented in Table 1 below and as used by the center for the purpose of predicting discretionary expenditures, shows different movements. This is the case regarding the time when the recession of 1970 was first predicted (May and August 1969, and not November 1969 as indicated in Table B-2) as well as for the winter of 1971-72. In Table B-3 (page 113) Juster and Wachtel present an index of expected price change derived from the center's data on consumers' price expectations. They conclude from the table that "the current inflation is largely

Inflationary Finance and the Welfare Cost of Inflation

Abstract: This paper applies previous theoretical and empirical results on inflation and demand for money to a study of inflationary finance and the welfare cost of inflation. The amount of revenue generated by a steady inflation is derived as a function of the inflation rate and some underlying parameters. Empirically, the revenue-maximizing rate is on the order of 140 percent per month with the corresponding revenue approximating 15 percent of national income. It is argued that hyper-inflations become unstable when the revenue-maximizing rate is exceeded. Because inflation leads to higher transaction costs (resulting from greater payment frequencies and reduced use of "money" as a payments medium), there is a net social cost attached to inflationary finance. The model implies that marginal collection costs of inflationary finance exceed 50 percent for all positive rates of inflation-hence, alternative means of raising revenue should be socially preferable. The analysis also provides estimates of the social gain from moving to the optimum quantity of money as 1-3 percent of income.(This abstract was borrowed from another version of this item.)

The Expectations Hypothesis and the Aggregate Wage Equation: Some Empirical Evidence for Canada'

Abstract: Dating back to the original pioneering work of Phillips [18] in 1958, the money-wage/unemployment trade-off has been subjected to extensive empirical investigation by numerous economists using data for a number of different countries.2 In general, the trade-off originally discovered by Phillips for the United Kingdom has been confirmed, although subsequent work has shown that other variables also are important in determining the percentage change in money wages. Recently, a number of authors have sought to develop a sounder theoretical basis for the observed relationship. One theory which has recently been receiving increasing attention is the so-called expectations hypothesis. This theory develops money-wage equations which depend upon future price expectations and/or money-wage expectations, as well as the unemployment rate.3 One particularly controversial aspect of this theory is the magnitude of the coefficient of the expectations variable in the relationship. In the absence of money illusion and under perfect competition, individuals should ultimately fully anticipate the inflation, implying that the coefficient should be unity. This in turn would imply the absence of a long-run money-wage/unemployment trade-off, or, equivalently, mean that the long-run Phillips curve is vertical, passing through the "natural" rate of unemployment (Fried

A Note on Inflation and the Saving Rate

Abstract: IN AN EARLIER PAPER FOR Brookings Papers on Economic Activity, we presented findings on the relation between price inflation and consumer saving in the context of examining the role of expectational variables in consumer spending and saving decisions.' The paper focused primarily on durable goods expenditure models, and presented evidence on the usefulness of explicitly expectational variables in such models. We also looked briefly at a relatively simple saving function to see if the same expectational variables that were associated with durable goods expenditure decisions also had an impact on saving decisions. This report focuses entirely on saving, and is concerned primarily with models that can be used to predict the personal saving rate. In this report, we examine three sets of variables for their impact on the saving rate. The first is personal taxes and transfer payments, which the evidence suggests have a strong initial impact on observed saving behavior. Second, we include both the levels of and changes in the unemployment

Inflation and the Consumer

Abstract: THE STUDY BY F. Thomas Juster and Paul Wachtel in an earlier issue of Brookings Papers on Economic Activity' provides a most useful confirmation of considerations about consumers' reactions to inflation presented by this writer over many years. Juster and Wachtel make extensive use of data collected by the Survey Research Center's quarterly surveys of changes in consumer attitudes and expectations. The appendix to the article presents two tables on data used, both of which contain adjusted data. The discussion of the paper indicates that the readers have received a misleading impression about survey findings during the last few years. Therefore, some of the original survey data are reproduced in this communication. Table B-2 (page 112) presents the changes in the center's index of consumer sentiment as "filtered" by Juster, who introduced a considerable lag. The unadjusted index, as presented in Table 1 below and as used by the center for the purpose of predicting discretionary expenditures, shows different movements. This is the case regarding the time when the recession of 1970 was first predicted (May and August 1969, and not November 1969 as indicated in Table B-2) as well as for the winter of 1971-72. In Table B-3 (page 113) Juster and Wachtel present an index of expected price change derived from the center's data on consumers' price expectations. They conclude from the table that "the current inflation is largely

Stochastic Simulation of Monetary Rules in Two Macroeconometric Models

Abstract: The effects of different monetary rules on the rates of inflation and unemployment are studied by stochastic simulation of the Federal Reserve Board-MIT-Pennsylvania (FMP) Econometric Model and the St. Louis “Monetarist” Model. A number of heuristic and more formal statistical methods are used in evaluating the results. It is shown that simple feedback control rules—involving proportional and derivative controls—reduce the variability of the target variables relative to the rule in which the money supply is increased at a constant rate. The improvement is considerably greater in the St. Louis model than in the FMP model.

The Optimal Full-Employment Surplus

Abstract: In this paper we find the monetary-fiscal mix that will lead to the Pareto-optimal amount of saving and investment. Because knowledge and foresight are imperfect, the monetary-fiscal policy mix affects consumption and the equilibrium interest rate, at full employment without inflation. Optimal policy balances different offsetting failures of household foresight against each other to approximate the results of perfect foresight. It also offsets the distortion in aggregate saving and investment due to the taxation of income from capital.

Simulations of Monetary Rules in the FRB-MIT-Penn Model

Abstract: THE INVESTIGATIONS REPORTED in this paper are directed to the question of the type of monetary rule which should be used if a rule is to be adopted. The rule usually considered in discussions of "rules versus discretion" is that of a constant growth rate of the money supply [4,7,8]. However, results in control theory (introduced to economics by Tustin [14], Phillips [12] and Holt [9], and investigated more recently by others) suggest that rules in which policy variables are automatically adjusted in response to deviations of target variables from desired levels (proportional controls) and in response to the rate of change of target variables controls) can be stabilizing relative to a constant growth rate rule. Whether such controls produce significant gains in stability in models of the economy is not, however, a trivial question, for these models may have characteristics-such as very long lags-which make the gain from use of adaptive controls of little significance. For instance, it will be seen, in our simulations, that proportional controls do not lead to sizeable increases in stability. In this paper, we report the results of simulations of some monetary rules in the FRB-MIT-Penn (FMP) Econometric Model for the period 1956.I through 1968.IV. The simulations are directed to the question of whether, in this model, for the period covered, the variability of the rates of inflation and unemployment produced under a constant growth rate rule can be reduced by following some simple rule of

Recession as a policy instrument: Israel 1965-1969

Abstract: Explores the experience of one developing country, Israel, in applying the traditional techniques of monetary and fiscal policies to the problems of inflation and expanding exports.

Money Supply, Interest Rates, and the Yield Curve

Abstract: THE EFFECT OF MONEY on interest rates is a subject that has a long and controversial history in economics. The mercantilistsl believed an increase in the supply of money would result in a fall in the rate of interest. It was argued that since interest is the rental price of money, the more money there is the lower this rental price must be. Others, David Hume [6] for example, disagreed with the mercantilists' purely monetary theory of the rate of interest. Hume pointed out that an increase in the supply of money would result in a proportionate increase in the price level and as a result there would be no increase in the real money supply and no fall in the interest rate. However, he argued that the price level would not adjust instantaneously to changes in the money supply and in the intermediate situation between the increase in the money supply and the increase in the price level the interest rate could fall (but this fall would only be temporary). More recently, John Maynard Keynes [7] argued that an increase in the supply of money would result in a fall in the interest rate (unless the IS curve was horizontal). Although Keynes' theory has strong similarities to the mercantilists' theory, Keynes qualified his theory by assuming the price level was fixed. As such, his effect of money on interest rates can be interpreted as a short-run effect (similar to the effect of money on interest in Hume's 'intermediate situation'). The above theories implicitly assume that if the price level changes it would be a once and for all change, i.e., the expected rate of inflation is zero. In such models there is no need to distinguish between real and nominal rates of interest. However,

Inflation and Saving through Life Insurance: Comment

Abstract: In a recent issue of this Journal,' Seev Neumann tests the hypothesis that inflation is not adverse to "saving through life insurance" and concludes by accepting the hypothesis. This comment suggests several weaknesses in Neumann's methodology and develops and tests an alternative model which is judged to be a better test of the hypothesis. We will conclude that Neumann is correct with respect to the question of the effect of the expected rate of inflation but he is incorrect with respect to the question of the effect of the expected level of the time path of future prices on "saving through life insurance. We find the following weaknesses in Neumann's methodology:

Market Power and Wage Inflation

Abstract: The interactions between a firm's oligopoly power and the wages paid to its employees have been discussed in both static and dynamic contexts. Most of the interest in the static aspects of this problem stems from the theory of countervailing power between large firms and multiplant unions which was proposed by Galbraith [4]. This theory suggests that unions will organize in industries where product-market power exists, and that both imperfections will tend to raise wages there above what they would be in a competitive economy.' It does not, however, contain any implications for the behavior of wages over the business cycle, although some work has attempted to demonstrate that wage changes are larger in concentrated industries.2 In this study we ex-

A Neo-Classical Approach to the Determination of Prices and Wages

Abstract: In most macro-economic models of Canada, the United Kingdom and the United States, prices and wages are determined in a Phillips-curve framework. In the original formulation the rate of change of wages is dependent on the rate of unemployment only. In subsequent formulations effects of rate of change of consumer prices and of productivity have been brought in to explain the rate of change of wages. However, the main emphasis is still on the trade-off between inflation and unemployment. In this paper we argue that, while this approach may be reasonable for a short-term model, it is inappropriate for a longer-run analysis. We argue that this approach does not explain the trend rate of growth of wages (and prices), but only the movement around the trend, with reference to unemployment and such other factors. In the longerrun analysis the trend rate of growth is the important matter to explain, and this requires a reformulation of the prices and wages equations. An important piece of information we use for this reformulation is the fact that the wage share has been stable in a secular sense, and this implies that in the long run both price and productivity changes are passed on to wages.2 This leads us to a productivity theory of real wages which we find explains reasonably well the movements in wages in the post-war period in Canada. Since the real-wage equation implicitly assumes absence of "money illusion" in the labour market, it determines only the ratio of money wages to prices and not their absolute levels. The latter has to be determined with reference to money supply, level of real output, and so on. Since these equations are based on classical economic theory and we draw inspiration from the work of such eminent neoclassicists as M. Friedman and D. Patinkin, we call our approach a neoclassical approach to prices and wages to be distinguished from the Phillips (or Keynesian) approach. As we note below, when viewed in the framework of long-run analysis, there is still some trade-off between unemployment and inflation, but the degree of trade-off is not quite so great as that obtained by traditional analysis. The main message

Inflation and Real Interest Rate: A Long-Term Analysis

Abstract: When the cost of living is not stable, the rate of interest takes the appreciation and depreciation into account to some extent, but only slightly, and, in general indirectly. That is, when prices are rising, the rate of interest tends to be high but not so high as it should be to compensate for the rise, and when prices are falling, the rate of interest tends to be low, but not so low as it should be to compensate for the fall. [Fisher 1930, p. 43]

A Reply to Gordon Tullock

Abstract: The connection between unemployment and inflation is the major unsolved problem of macroeconomics-theory, econometrics, and policy. In the May 6, 1971, issue of the New York Review of Books, we published an article on this problem, addressed to non-economists. In particular we discussed the diff1cult choices then confronting macroeconomic policy in the United States. The policy alternatives, as we set them forth, were (a) to prolong the recession and 52 -6So unemployment as long as necessary to eliminate inflation, (b) to impose wage and price controls, and (c) to take expansionary measures to reduce unemployment, accepting the inflationary risks and consequences. We believed that the third alternative was receiving insufficient attention in the national debate, and we sought to make the case for it in preference to the other two. We argued that the unfair distributional effects of inflation had been vastly exaggerated, and that inflation's real victims-old people on private pensions and small savers-could be compensated through government action (removing restrictions on interest payments on small deposits, making available purchasing-power-bonds, requiring cost-of-living adjustments in pensions). We also advocated some structural reforms to diminish the inflationary bias of labor and product markets. Most readers of this journal will not have read our article, and the capsule summary of it above cannot suffice for them to judge the accuracy of Gordon Tullock's interpretation of it or the ments of his general and local attacks upon it. Consequently we will gladly send a copy of the article to any reader who requests it of us.l