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Monetarism Notes
Econ 102
Mr. Smitka
Winter 2003
Prime Minister Kakuei Tanaka, 1972
田中角栄
• 列島改造計画 Plan to Rebuild the Japanese Archipelago
– Slowdown ca. 1970 encouraged fiscal policy
– Tanaka started in the construction industry, used that to
raise campaign funds for faction / political party
• 1971 ¥/$ appreciation: end of “Bretton Woods”
– huge inflow of dollars, bought to lessen forex shift but
boosted money supply / lowered interest rates
• Sum: both stimulative MP and stimulative FP
– Double-digit inflation by 1973
Oil Crisis
• October 6, 1973 Yom Kippur War
– OPEC already more active
– Boom not just in Japan but also US, Europe
• I worked overtime, 7 days / week, at UAW wages …
• Demand made cartel discipline moot
– Oil prices quadrupled
• Japan imported 99+% of oil
• Huge boost in inflation
• Inflation jumped to 25%
– Panic buying: shoppers trampled to death buying TP
Bank of Japan reaction
April 1973
4.5% --> 5%
May 1973
5.5%
July 1973
6%
August 1973
7%
December 1973
9%
April 1975
Began lowering
Money Supply
M1
Currency
Deposits
M1 Growth
600,000
35.0%
30.0%
500,000
25.0%
400,000
20.0%
300,000
15.0%
200,000
10.0%
100,000
5.0%
1977.01
1976.07
1976.01
1975.07
1975.01
1974.07
1974.01
1973.07
1973.01
1972.07
1972.01
1971.07
1971.01
1970.07
1970.01
1969.07
0.0%
1969.01
0
Money Supply
Wholesale Prices, Monthly Rate (Annualized)
M1 Growth
Wholesale Prices vs Previous Year
140.0%
45.0%
40.0%
120.0%
35.0%
100.0%
30.0%
80.0%
25.0%
60.0%
20.0%
15.0%
40.0%
10.0%
20.0%
5.0%
0.0%
0.0%
1975.10
1975.07
1975.04
1975.01
1974.10
1974.07
1974.04
1974.01
1973.10
1973.07
1973.04
1973.01
1972.10
1972.07
1972.04
1972.01
1971.10
1971.07
1971.04
1971.01
1970.10
1970.07
1970.04
-5.0%
1970.01
-20.0%
Analytic issues
• Time lags
– Recognition
– Implementation
– Impact
• Time consistency
– Short-run versus long-run
• Structural issues
– Institutional change renders historical relationships
(model parameters) misleading
Monetarist models
• MP = ? … what should be goals?
• MV  PY … an identity: true by definition
– M is money stock
– V is velocity, ability of a given amount of
money to support economic activity
– P is price level, Y real GDP
• So PY is nominal GDP
• Can this framework be used?
MV  PY
• IF velocity “V” is stable
• AND the link between nominal and real
GDP is predictable
• THEN can tie changes in money supply to
changes in “P” – that is, inflation
• But in fact
– V is noisy and shifts with institutional change
– PY is not easy to decompose
Sample arithmetic
• MV  PY…to use, add growth rates
– M plus 5%
• V ±2% since volatile / large error component
– Then PY can range from +7% to +3%
• Real Y avg +2% but can fall as much as -1%
– [increase can be more short-run, coming out of recession]
– So P can range from:
• 7% - (-1%) = 8%
• 3% - 2% = 1%
• Monetarist framework offers little insight under
“normal” growth rates of US and post-1973 Japan
Sample arithmentic #2
• M = +25%
• V ±2% as before
– Then PY can range from 27% to 22%
– Even with real Y = +5% inflation is high
– But oil crisis ---> Y = -2% [or worse!]
• So inflation 24% ≈ 29%
• High “M” growth is indicative of problems
Other aspects
• FP side effects
– Implications of lifetime consumption model
• MP side effects
– Do you really want low investment to persist?
– Are big swings in forex rates desirable?
• International side effects
– How to respond to exogenous forex shifts?
Calulation
• Nominal change x = new value is (1 + x) times old
• Ditto inflation π ==> new value is (1 + π) old
• Hence the net change is:
1+x =
1 + x - π (+ error term)
1+π
• Hence real change ≈ x - π
• This approximation is accurate when x & π are
single-digit