Showing papers on "Inflation published in 1983"

Rules, Discretion and Reputation in a Model of Monetary Policy

Abstract: In a discretionary regime the monetary authority can print more money and create more inflation than people expect. But, although these inflation surprises can have some benefits, they cannot arise systematically in equilibrium when people understand the policymaker's incentives and form their expectations accordingly. Because the policymaker has the power to create inflation shocks ex post, the equilibrium growth rates of money and prices turn out to be higher than otherwise. Therefore, enforced commitments (rules) for monetary behavior can improve matters. Given the repeated interaction between the policymaker and the private agents, it is possible that reputational forces can substitute for formal rules.Here, we develop an example of a reputational equilibrium where the out-comes turn out to be weighted averages of those from discretion and those from the ideal rule. In particular, the rates of inflation and monetary growth look more like those under discretion when the discount rate is high.

A Positive Theory of Monetary Policy in a Natural-Rate Model

Abstract: A discretionary policymaker can create surprise inflation, which may reduce employment and raise government revenue. But when people understand the policymaker's objectives, these surprises cannot occur systematically. In equilibrium people form expectations rationally and the policymaker optimizes in each period, subject to the way that people form expectations. Then, we find that (1) the rates of monetary growth and inflation are excessive; (2) these rates depend on the slope of Phillips curve, the natural unemployment rate, and other variables that affect the benefits and costs from inflation; (3) the monetary authority behaves countercyclically; and (4) unemployment is independent of money policy. Outcomes improve if rules commit future policy choices in the appropriate manner. The value of these commitments--which amount to long-term contracts between the government and the private sector--underlies the argument for rules over discretion.

Estimates of the Variance of U. S. Inflation Based upon the ARCH Model

Abstract: IT IS GENERALLY AGREED that the unpredictability of future inflation is a major component of the welfare loss associated with inflation. Perfectly predicted inflation might induce some costs through institutional rigidities, governmental interference, and transaction costs, but, in the long run, these should be rather minimal as these institutions adopt various forms of indexing. When inflation is unpredictable, risk averse economic agents will incur a loss, even if prices and quantities are perfectly flexible in all markets. Inflation is a measure of the relative price of goods today and goods tomorrow; thus, uncertainty in tomorrow's price impairs the efficiency of today's allocation decisions. Friedman, in his Nobel lecture [8], argues convincingly that higher variability of inflation would lead to decreased output, ceteris paribus. He then conjectures that higher rates of inflation are generally associated with higher variability of inflation and presumably greater uncertainty about future rates. If this is true, then higher rates of inflation would also be associated with low levels of output, which implies a positively sloped Phillips curve. This paper uses a new statistical technique (ARCH) to estimate the conditional mean and variance of inflation from U.S. time series data. The main finding is that the variance of inflation in the seventies was only slightly greater than in the sixties

Currency Substitution and Instability in the World Dollar Standard: Comment

Abstract: Myron Ross correctly points out in his comment that U.S. price inflation is better predicted by the American money supply (MlUS) than by the broader ten-country world money supply (MlW) over the whole statistical time-series from 1960 to 1980 provided in McKinnon's 1982 article. Specifically, he showed that American price inflation is more highly correlated with MlUS lagged one or two years than with MlW similarly lagged. However, McKinnon's present-tense assertion that "In general, growth in the world money supply is a better predictor of American price inflation than is American money growth" applies only to the weak dollar standard of the 1970's and early 1980's-as his preceding discussion intended, but failed to indicate clearly. Only in this later period of volatile exchange rates and price-level instability in the United States do alternative hard currencies (such as the yen and deutsche mark) become competitive as international stores of value and units of account. Hence, international currency substitution-associated with the ebb and flow of speculation against or for the dollar-significantly destabilized the demand for MlUs in the 1970's and 1980's. And only in this later period might one expect the sum of these internationally substitutable monies, Ml, to predict world, and perhaps even American, price inflation better than does Mlus. In contrast, during the strong dollar standard of the 1950's and 1960's, the dollar was unchallenged as international money. Exchange rates were (by and large) convincingly fixed: speculation for or against the dollar was incapable of substantially altering U.S. interest rates or of directly affecting the demand for MlUS. Because cyclical international influences did not then destabilize the demand for dollars, MlUS was by itself a fairly efficient predictor of American prices. Thus Ross's statistical results for the period 1960 to 1980 show somewhat greater predictive strength in Mlus, compared to Ml', because the 1960's data outweigh the dissimilar data of the 1970's. Let us instead partition the sample of IMF data around the year 1970, whence began the transition from fixed to fluctuating exchange rates and the maturation of alternative monetary systems in Europe and Japan. After applying similar statistical correlation procedures to those used by Ross, we show a striking structural shift in the world's monetary system: the explanatory power of Mlw increases sharply as that of MlUS declines moderately (Tan, 1982). For the early period of 1960 to 1970, Table 1 shows simple correlation coefficients between annual percentage changes in money supplies and changes in American and world wholesale price indices. The MlUs provides a good explanation of U.S. prices and of world prices one to two years hence, whereas the broader definition of Mlw (in which MlUs enters with a 50 percent weight) does surprisingly poorly, being insignificantly correlated with American or world prices. Apparently, money growth in industrial countries other than the United States was not then an independent source of worldwide inflationary pressure during the strong dollar standard. Table 2 shows the same simple correlations between percentage changes in prices and money for the weak dollar standard of * Stanford University. Please note that a typographical error giving the last word in the original title as "Market" appeared on the cover of the June 1982 issue of this Review. The title was correct in the table of contents and on the article.

Rational Expectations and Macroeconomic Forecasts

Abstract: This paper presents extensive results from testing for bias and serially correlated errors in a large collection of quarterly multiperiod predictions from surveys conducted since 1968 by the National Bureau of Economic Research and the American Statistical Association. The tests of the joint null hypothesis that the regressions of actual on predicted values have zero intercepts and unitary slope coefficients are very unfavorable to the expectations of inflation, but they show the forecasts of several other variables in a generally much better light. There have been strong tendencies for the forecasters in this period to underestimate inflation and overestimate real growth.Considerable attention is given to the effects of the sample size--the issue of the power of the tests--and also to the extent and role of autocorrelations among the residual errors from these regressions.Rationality in the sense of efficient use of relevant information implies the absence of systematic elements in series of errors from the forecaster's own predictions, measured strictly in the form in which such errors could have been known at the time of the forecast. The frequencies of significant auto-correlations among errors so measured vary greatly across the forecasts for different variables, being very high for inflation, high for inventory investment and the unemployment rate, and much lower for most of the predictions ofthe other variables covered (rates of change in nominal and real GNP and expenditures on consumer durables). The corresponding tests for the group meanforecasts show much less evidence of serially correlated ex ante errors, except for inflation.

Optimum Pricing Policy under Stochastic Inflation

Abstract: We describe aggregate inflation as a stochastic process in which the rate of change of the price level can be positive or zero, where the times spent in each state are of random duration. This class of processes includes Two-State Markov Chains and Renewal Processes as special cases. It is shown that the optimal pricing policy of a monopolistic firm with non-convex costs of price adjustment is (S, s) in its real-price, i.e. its nominal price relative to the price level. A basic certainty-equivalence result is proved: i.e. the firm behaves as if it faces a certain and fixed rate of inflation, higher than the actual expected rate, the difference between the two rates being a risk premium which depends on the real interest rate and the parameters of the stochastic process. One can thus apply previous results from the case of certainty (Sheshinski and Weiss, Review of Economic Studies, 1977) to obtain comparative static results. In particular, one finds that an increase in the variance of expected inflation leads firms to choose a pricing policy with larger amplitude in real price. The paper also addresses the question of consistency in firms' expectations when the price level is determined by the firms' actions. In this paper we consider pricing policies of individual firms in an inflationary environment. Each firm expects the general price level to increase and must determine the rate of increase of its own price. It is assumed that the firm incurs an adjustment cost when it changes its nominal price. Consequently, firms choose to change prices occasionally rather than continuously.

Real Interest, Money Surprises, Anticipated Inflation and Fiscal Deficits

Abstract: THE hypothesis attributed to Fisher (1930) and more recently the innovative investigation by Fama (1975) have predisposed many economists to treat the expected real rate of interest as a constant. At the very least, as a "real" magnitude, the expected real interest rate is appealingly viewed as being independent of monetary phenomena. The late 1970s and early 1980s have produced events which force reevaluation of the maintained hypothesis of constancy of the expected real rate (hereafter referred to as the "real rate"). For example, from December 1980 to June 1981 the expected rate of inflation fell by 165 basis points from an annual rate of 10.51 % to an annual rate of 8.86%.' Over the same period 3 month Treasury bill rates continued to remain largely between 14% and 16% with average yields of 15.02% in December 1980 and 14.95% in June 1981. In order to reconcile such facts, one must either believe that security markets no longer fully reflect changes in anticipated inflation in nominal market rates, or that a large drop in anticipated inflation which is not accompanied by a drop of similar magnitude in nominal interest rates, is due to an offsetting rise in the real rate.2 Statistical investigations regarding the possibility of movements in the real rate have appeared with increasing frequency since publication of Fama's (1975) provocative article.3 Nelson and Schwert (1977) argued that Fama's test of the joint hypothesis of market efficiency and constancy of the real rate was not sufficiently powerful and after applying more powerful tests concluded that the data permitted rejection of the hypothesis of constancy of the real rate. Other investigations including those by Carlson (1977), Garbade and Wachtel (1978) and Levi and Makin (1979) have rejected the hypothesis of constancy of the real rate while tending to support the hypothesis that market interest rates include an efficient inflationary premium. Tanzi (1980) has, along with others, emphasized the role of taxes in interest rate determination. More recently investigators have moved from merely testing the hypothesis of constancy of the real rate to searching for an explanation for the real rate movements suggested by a large body of statistical evidence. Mishkin (1981) and Fama and Gibbons (1982) have investigated the relationship between the real rate and anticipated inflation suggested by Mundell (1963) and Tobin (1965).4 Levi and Makin (1979, 1981), Hartman (1981) and Hartman and Makin (1982) have considered effects of inflation uncertainty on the real rate. Dwyer (1981) has found that the real rate is independent of predictable changes in the money supply. This paper derives a Fisher-type interest rate equation from a structural model similar to that employed by Sargent (1973) for other purposes. The primary differences involve inclusion of a government sector and a simple open economy specification along with introduction of a role for Received for publication February 22, 1982. Revision accepted for publication September 3, 1982. *University of Washington and National Bureau of Economic Research. This work was supported by the National Science Foundation under (irant No. SES-8112687. I would like to thank without implicating Charles Nelson, Richard Hartman and especially Andrew Criswell for excellent help in estimating the equations. An earlier version of this paper was presented at an FMME Conference at NBER where many useful suggestions were provided. ' This figure is based on Livingston survey data for 6 month horizon expectations regarding the consumer price index (CPI). The 12 month horizon figure for CPI also indicated a drop of 165 basis points while 6 and 12 month horizon numbers for WPI indicated drops of 192 and 174 basis points, respectively. Updated Livingston survey data are now compiled by the Federal Reserve Bank of Philadelphia. 2Summers (1982) has argued that nominal interest rates do not adjust by the full amount implied by the Fisher hypothesis modified to allow for marginal tax rates on interest earnings. His results based on both preand post-World War II data arise from equations which employ actual inflation rates in place of anticipated inflation and which generally do not include variables to control for movements in the expected real rate. 3Even well before the investigations discussed here Irving Fisher himself reported, based on an investigation of market interest rates during the late 19th and early 20th centuries in London, New York, Berlin, Calcutta and Tokyo, that ' the real rate of interest in terms of commodities is from seven to thirteen times as variable as the market rate of interest expressed in terms of money" (Fisher (1930), p. 415). 4 Mishkin (198 1) found a significant negative impact upon the real rate of a lagged actual (CPI) inflation rate taken as a proxy for anticipated inflation. An ARIMA (0, 1, 1) inflation model with a seasonal MAI term also provided an expected inflation proxy with a significant negative impact on the real rate. Mishkin (1982) is discussed below.

Federal Borrowing and Short Term Interest Rates

Abstract: This paper is an empirical study of the effects of Federal government borrowing on short term interest rates. It is often taken for granted that increases in Federal borrowing cause higher short term rates, but little empirical support exists for this assumption. In fact, this paper demonstrates that Federal borrowing is a relatively unimportant (and insignificant) determinant of short term rates. An implication of this result is that financial crowding-out effects of government deficit spending may not be overly large. Postulates about interest rate behavior are the driving force behind many hypotheses of the crowding-out literature. However, these interest rate effects have received relatively little direct attention in this literature. This is surprising since, as a general rule, the stronger the interest rate effect is, the stronger the crowding-out effect will be. An empirical determination of the size of the deficit spending interest rate effect gives some empirical content to the crowding-out controversy. In Section II of this paper, the relationship between Federal borrowing, interest rates, and crowding-out is discussed and a loanable funds model of short term interest rates is developed. In Section III, the regression model is generated and tested. The essential result is that variation in three month Treasury Bill rates is caused by expected inflation, changes in the monetary base, and by changes in the level of economic activity. There is no statistically significant relation between short term interest rates and Federal borrowing. In Section IV, additional regression tests are performed which confirm the results in Section III, and the problem of simultaneous equation bias is discussed. The final part of the paper is a discussion of some implications of the results reported in Sections III and IV.

Some macroeconomic implications of alternative compensation systems

Abstract: A basic theme of this paper is the idea that some structural reform of employee compensation arrangements is necessary to make reasonable price stability compatible with reasonably full employment. In this view even the best designed macroeconomic policies are much too aggregative to get at the heart of the stagflation problem. The ultimate solution involves going inside the workings of a modern capitalist economy and correcting the underlying structural flaw directly on the level of the individual firm. Stagflation represents an especially intractable policy dilemma for macroeconomics. Without a decisive tendency of the economic system to remain near full employment, there is a strong prima facie case for fighting recessions by exogenously stimulating aggregate demand. But the usual Keynesian expansionary policies tend to impart an inflationary inertia that is difficult to choke off. And of course the basic strategy for fighting inflation is to cool down the economy by restrictive monetary and fiscal policy thereby increasing unemployment and closing the viscous circle. Because the practical macroeconomic policies for dealing with unemployment and inflation are so diametrically opposed, stagflation is a pervasive structural problem when, for whatever reason, there is basically an unfavourable short run tradeoff between unemployment and inflation. Economic policy tends to vacillate between expansion of demand to fight unemployment and restriction of demand to fight inflation, polarising the electorate and distracting society from dealing effectively with its underlying 'real' economic problems. Even the difficulty of attaining 'external balance' in foreign accounts is largely a spillover into the international payments arena of an inability to achieve an acceptable 'internal balance' between full employment and price stability.' This paper takes what might be called a comparative systems approach to the problem of stagflation. At the heart of modern industrial capitalism is an incredibly complicated system of overlapping monopolistic competitors.2 A starting point for the paper is the realisation that the coordination difficulty which can cause some systems to suffer involuntary unemployment is not inherent in laissez faire private enterprise per se. It is closely tied to one particular property of a conventional wage payment system: namely, compensation of each firm's employees is stuck to an outside numeraire (whether money, or a cost of

Exchange Rates and International Macroeconomics

Abstract: This volume, presenting some of the finest new research on exchange rates and international macroeconomics, contains papers and critical commentary by thirty-two leading economists. Taken together, these papers provide sound evidence about the effects of real and monetary factors on exchange rates and extend the analyses of exchange rates and international macroeconomics by outlining the kinds of behavior and institutional arrangements that can be incorporated into such analyses. Both empirical and theoretical research are represented, and the contributors analyze such issues as the performance of various models of exchange rate determination, the role of risk and speculation in the forward market for foreign exchange, the rational expectations hypothesis in such markets, the performance of monetary policy in ten industrial countries, the role that labor market contracts play in exchange rate policies, the effect of he oil shocks on the evolution of exchange rates, and the output cost of bringing down inflation in the open economy.

Union Wage Settlements during a Disinflation

Abstract: This paper examines the role of union wage contracts in the persistence of inflation, and the implication of these contracts for the problem of disinflation in the United States. A quantitative model of overlapping con- tracts explicitly oriented toward the major union sector is developed. The model takes account of expectations of future wage, price, and employment conditions as in more aggregated models that have been used in macroeconomic research. In addition, the distribution of workers according to contract length as well as deferred wage increases and escalator clauses are explicitly used in the model. The main aim of the model is to determine the constraints which these contracts impose on disinflation paths. The model indicates that the maximum speed of disinflation is extremely slow in the early phases -- if a rise in unemployment is to be avoided -- but increases considerably before the new lower rate of inflation is reached. The disinflation path is considerably slower than that observed after hyperinflation periods. However, the existence of a path of inflation reduction raises questions about whether the institution of union wage con- tracts is really the direct cause of costly disinflations, or whether their influence works indirectly by raising credibility problems about a monetary disinflation.

Why Real Interest Rates Were So Low in the 1970's

Abstract: The economic turmoil of the 1970's resulted in record postwar increases in inflation, unemployment, and nominal interest rates. Yet, it was declines that were hardest to explain. The average real value of a share of common stock plummeted. Productivity growth evaporated. Real interest rates, measured as the spread between nominal interest rates and the inflation rate, turned negative (see Table 1). Over the past decade, an explosion has occurred in the amount of attention paid to the relationship between nominal and thus real interest rates and expected inflation rates. A good deal of this effort has been directed toward empirical analysis of the Fisher neutrality hypothesis that nominal rates respond one for one with expected inflation rates. Most empirical tests of the Fisher hypothesis have been bivariate; interest rates were regressed on a constant and on actual or expected inflation measures. Estimates of the impact of inflation on interest rates in these and even in extended models are often significantly below one, are often statistically imprecise, and tend to be unstable over time.' The middle column of Table I reflects this. The coefficient of inflation on nominal interest rates there drops from 0.78 to 0.59 in the latter 1970's. Another branch of work on nominal interest rates has concentrated on the institutional impediments to the Fisher hypothesis. Robert Mundell and James Tobin demonstrate that nominal rates change by a smaller amount than the expected inflation rate does when a real balance effect exists and money pays no interest. Michael Darby and Martin Feldstein, on the other hand, argue that nominal rates should exhibit a greater-thanunity response to expected inflation due to the nature of U.S. income tax laws.2 Here I estimate the relation between interest rates, expected inflation, and real forces. Such estimates are required for evaluating the effects of inflation on saving, investment, the distribution of income, and the redistribution of wealth. To generate estimates of the net impact of these various factors on interest rates and to avoid the identification and simultaneity problems masked, but not often remedied, by instrumental variables techniques, I employ only exogenous regressors. To buttress the argument, I examine the individual links in the chain which are summarized in the reduced form. The novel aspect of the model presented in Section I is its addition of aggregate supply shocks to the determination of interest rates. I trace the reduction in the supply of complementary factor inputs in the 1970's to a decline in the demand for capital and therefore in real interest rates. The inclusion of this supply force along with expected inflation allows one to distinguish between two, offsetting effects on interest rates: the depressing effect on real rates through lower investment demand and the elevating effect on nominal rates of higher expected inflation. The results in Section II not only strongly support the economic and statistical importance of supply shocks on real interest rates, but also resolve some longstanding interest rate puzzles. Allowing for the impact of factor supply produces a significant estimated response to expected inflation for a sample that ends prior to late 1960's. The magnitude *Assistant professor, School of Business Administration, University of California-Berkeley. I would like to thank George Akerlof, Robert J. Gordon, Robert A. Meyer, Joe Peek, Janet Yellen, the members of the Economic Analysis and Policy seminar at Berkeley, participants at the NBER Conference on Inflation and Financial Markets, and anonymous referees for helpful comments. Data Resources supplied data and computational services. Financial support was provided by the Berkeley Program in Finance and NSF grant SES8109093. Linda Pacheco supplied able research assistance. Errors of omission or commission are my responsibility. 'See William Gibson, David Pyle, John Carlson, and Thomas Cargill and Robert Meyer. 2Maurice Levi and John Makin derive the reducedform effect of expected inflation on nominal interest rates as a function of the structural parameters.

Assessing the variability of inflation

Abstract: Although there has been much argument over the impact of variable inflation rates upon economic performance, there has been surprisingly little attempt to define the term "variability of inflation" carefully or to test proposed hypotheses connecting variability and the level of inflation. Precise definitions are given in the paper and a model is constructed showing that the level/variability hypothesis may be formulated in terms of the presence of heteroscedasticity in a regression model. This theoretical model is used to criticize existing studies, while an empirical study with Australian data illustrates the application of the approach.

Theories of inflation

Abstract: A survey of the new theories of inflation that have developed over the past two decades in response to the inflationary pressures experienced by Western countries examines the shifting debate from explaining inflation as a "causal" process to explaining its increase as a result of constantly changing expectations.

The international transmission of inflation

Abstract: Inflation became the dominant economic, social, and political problem of the industrialized West during the 1970s. This book is about how the inflation came to pass and what can be done about it. Certain to provoke controversy, it is a major source of new empirical information and theoretical conclusions concerning the causes of international inflation. The authors construct a consistent data base of information for eight countries and design a theoretically sound model to test and evaluate competing hypotheses incorporating the most recent theoretical developments. Additional chapters address an impressive variety of issues that complement and corroborate the core of the study. They answer such questions as these: Can countries conduct an independent monetary policy under fixed exchange rates? How closely tied are product prices across countries? How are disturbances transmitted across countries? "The International Transmission of Inflation" is an important contribution to international monetary economics in furnishing an invaluable empirical foundation for future investigation and discussion.

Inflationary Finance under Discrepion and Rules

Abstract: Inflationary finance involves first, the tax on cash balances from expected inflation, and second, a capital levy from unexpected inflation. From the standpoint of minimizing distortions, these capital levies are attractive, ex post, to the policymaker. In a full equilibrium two conditions hold: 1) the monetary authority optimizes subject to people's expectations mechanisms, and 2) people form expectations rationally, given their knowledge of the policymaker's objectives. The outcomes under discretionary policy are contrasted with those generated under rules. In a purely discretionary regime the monetary authority can make no meaningful commitments about the future behavior of money and prices. Under an enforced rule, it becomes possible to make some guarantees. Hence, the links between monetary actions and inflationary expectations can be internalized. There is a distinction between fully-contingent rules and rules of simple form. A simple rule allows the internalization of some connections between policy act ion and inflationary expectations, but discretion permits some desirable flexibility of monetary growth.(This abstract was borrowed from another version of this item.)

Inflation and Social Consensus in the Seventies

Abstract: It is widely believed that the two oil price shocks of the I 970S played a major role in the increase in inflation in industrial countries. While this hypothesis is consistent with the timing of changes in inflation at the global level, it seems to break down when applied to individual countries cross-sectionally. For example, over the period I973-9 Switzerland had an average inflation rate of 4-7 % while in neighbouring Italy inflation averaged I5-6 % over the same period. Furthermore, inflation in the pre-OPEC period I97I-2 was actually higher in Switzerland than in Italy. It seems that a supply shock explanation of inflation in the seventies also requires an explanation of why different countries responded so differently to a similar set of shocks at the world level. The purpose of this paper is to offer such an explanation and to test the hypothesis with a cross-sectional equation accounting for differences in average inflation rates over the period I973-9 in eighteen OECD countries. This time period includes the year of the first OPEC shock (I 973) and the following six years up to the time of the second OPEC shock. The hypothesis to be tested is set in the framework of a model similar to that of Brunner et al. (i 980). The key features of the Brunner model are that the adjustment of real wage expectations is subject to lags and that labour supply is positively related to the difference between the perceived real wage and the expected or target real wage. Given these two assumptions, a negative supply shock gives rise to a period of stagflation whose intensity will be greater, the slower is the speed of adjustment of real wage expectations. The model of this paper extends the Brunner model in three ways. First, across countries the speed of adjustment of real wage expectations or targets is assumed to depend positively on the degree of 'social consensus' as proxied (negatively) by an indicator of average long run strike activity. Second, the model allows for the possibility of inflation inertia or systematically incorrect inflation expectations as well as a sluggish adjustment of real wage expectations. Third, the model incorporates the hypothesis that money supply growth will vary across countries according to variations in inflationary pressures as perceived by governments. The first section of the paper provides a discussion of the rationale for the key proposition regarding strikes and social consensus, as well as a brief discussion of the role of wage-bargaining institutions. Section II develops a theoretical model which yields a reduced form cross-sectional equation relating the average I 973-9

Costs and Benefits of an Anti-Inflationary Policy: Questions and Issues

Abstract: This paper analyses how the output or unemployment cost of achieving a sustainable reduction in the rate of inflation depends on the structure of the wage-price process and how the "sacrifice ratio" can be minimized. In models where the natural rate is invariant under the anti-inflationary policies, price level inertia is not sufficient for a positive sacrifice ratio. Without sluggishness in the core inflation rate, a zero sacrifice ratio can be achieved simply through intelligent demand management. With sluggish core inflation, the sacrifice ratio is positive unless intelligent demand management is complemented by cost-reducing fiscal measures o reffective incomes policy. Letting the exchange rate float does not reduce the sacrifice ratio. If core inflation is partly backward-looking and partly forward-looking, current core inflation may be a function of current and past expectations of future recessions. Conventional sacrifice ratio calculations ignore forward-looking aspects of behaviour and may therefore underestimate the true cost of disinflation. If there is hysteresis in the natural rate (e.g. through a gradual adjustment of the natural rate towards the actual rate) and if there is sluggish core inflation, the sacrifice ratio will become infinite.Whenever sluggish core inflation is present, credibility of the anti-inflationary (monetary) policy alone cannot obviate a positive sacrifice ratio.

The Hungarian Hyperinflation and Stabilization of 1945-1946

Abstract: Inflation in Hungary after World War II was the most intense on record. The reforms of August 1946 were immediately and entirely successful in stabilizing prices. This paper describes and analyzes the unique policies and institutions that produced these phenomena. Despite its severity, the Hungarian experience was consistent with the less extreme inflation and stabilization experiences examined by Sargent. Price stabilization was accomplished by fiscal rather than purely monetary measures and was, paradoxically, accompanied by rapid and prolonged money growth.

The Money Supply and Nominal Agricultural Prices

Abstract: In the early 1970s food and agricultural prices in the United States rose substantially faster than other prices. Now early in the 1980s, farm prices are depressed relative to other prices in the economy. Numerous explanations of the behavior of nominal agricultural prices in the past decade have been offered. These explanations may be broadly divided into two categories. The first is the structuralist explanation. It argues that real shocks in selected sectors of the economy, such as global crop failures, raise prices of certain goods. These price increases are later validated or accommodated by expansions in the money supply so that the prices of other goods need not decline. In contrast, monetarist inflation explanations argue that autonomous increases in the money supply lead or cause the price increases and do not just occur ex post to accommodate real shocks. Ultimately, both explanations recognize that without monetary expansion no long-run inflation can occur. The fundamental difference is

Inflation and Growth

Abstract: Models of inflation and growth in the sixties emphasized the portfolio substitution mechanism by which higher inflation made capital more attractive to hold relative to money, leading to higher capital intensity, and in the transition period to higher growth.The empirical evidence, however, is that growth and inflation are negatively correlated. Reasons for this negative correlation are investigated, and then embodied in a simple monetary maximizing model. Higher inflation is associated with lower growth because lower real balances reduce the efficiency of factors of production, and because there may be a link between government purchases and the use of the inflation tax. Comparative steady states and comparative dynamics is analyzed and the generally negative association between inflation and growth, both in steady states and in transition processes, is demonstrated.

The Effects of Inflation on Real Interest Rates

Abstract: One of the most obvious facts of recent monetary history is that high inflation is associated with high nominal interest rates. This association has been interpreted by many as supporting a superneutrality hypothesis: that an increase in inflation will not affect real interest rates in the long run.' However, the bulk of the evidence contradicts superneutrality. Beginning with Irving Fisher (1896, 1930), most empirical investigations have found that fully anticipated inflation has less than a unit effect on nominal interest rates, and thus reduces real interest rates even in the longest of runs. This has been shown under the assumption that expectations are formed rationally (Douglas Pearce, 1979), that they take the form of an arbitrary distributed lag on past inflation rates (Fisher, 1930; William Gibson, 1970), or that they are accurately represented by the Livingstone expectations data (Pearce; Kajal Lahiri, 1976). Lawrence Summers (1983) attempted to measure the long-run effect without an explicit theory of expectations. Regressing long swings in various nominal interest rates against long swings in inflation over various subintervals from 1860 to 1979, he found coefficients consistently less than unity. For the post-World War II era as a whole the coefficients were in the range of 0.5 to 0.75, with standard deviations of 0.08 to 0.33. A few studies have found coefficients close to unity (William Yohe and Denis Karnosky, 1969; Martin Feldstein and Otto Eckstein, 1970; Gibson, 1972; Lucas). But, as several authors have observed (Thomas Sargent, 1976; Robert Shiller, 1980; John Wood, 1981; Summers), these findings are limited to a particular period of U.S. history, approximately 1953-71. Furthermore, even a unitcoefficient would contradict superneutrality of the after-tax real interest rate, which would require a coefficient substantially greater than unity. Even taking into account the other inflation distortions in the tax system, Summers calculated that the coefficient ought to lie in the range of 1.3 to 1.5, far higher than observed. These empirical findings pose a challenge to traditional monetary theory, much of which implies that superneutrality should hold at least approximately. For example, the model of Miguel Sidrauski (1967) implies that the real interest rate should equal the marginal product of capital, which in the long run should equal the representative household's marginal rate of time preference. If this rate of time preference is a constant, then in particular it will be independent of the rate of inflation. If it is positively related to the household's wealth, or utility, then inflation can reduce the marginal product of capital somewhat through what are commonly called Mundell-Tobin effects. That is, higher inflation can reduce the demand for real balances, which reduces real wealth, which lowers the rate of time preference and leads to further capital accumulation.2 But this real balance effect on saving is commonly recognized to be too small to make *Department of Economics, Social Science Centre, University of Western Ontario, London, Canada N6A 5C2. We are grateful to Charles Adams, Norman Cameron, John Chilton, Jacob Frenkel, David Laidler, Ben McCallum, Baldev Raj, Brad Reid, Jack Weldon, John Whalley, Ron Winrck, and two anonymous referees for helpful discussions and comments on earlier drafts. All errors are attributable to transaction costs. 'Robert Lucas (1980) finds empirical support for the hypothesis, which he calls one of the central implications of the quantity theory of money. It has also been adopted by a wide range of more eclectic economists, as evidenced by its endorsement in two of the most popular macroeconomics textbooks (Rudiger Dornbusch and Stanley Fischer, 1981, pp. 454-58; Robert J. Gordon, 1978, pp. 289-91). 2These implications of variable time-preference can be drawn almost immediately from the work of Hirofumi Uzawa (1968). A graphical analysis is presented by David Laidler (1969b), who focuses on the logically equivalent question of the effects of paying interest on money.