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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