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Does monetary policy help close the gap between the rich and the poor?
Monetarism is the view within that variation in the money supply has major influences on national
output in the short run and the price level over longer periods; thus, targeting the growth rate of the money
supply is essential. Monetary policy does not help close the gap between the rich and the poor. In fact, many
would argue that while it can help both the rich and the poor, ultimately it helps the rich more than it helps
the poor. So in a way, it widens the gap (in a way that, arguably, doesn’t hurt the poor, but doesn’t help them
as much as it helps the rich).
The article, “ECONOMY: Rich-Poor Divide Worst Among Rich Countries”
(http://ipsnews.net/news.asp?idnews=44381) discusses this exact situation. The article says that “the United
States has the largest gap between its wealthiest and poorest households after Mexico and Turkey.” It’s
argued that changes in the money supply are disproportionately distributed throughout an economy,
and as a result wealth is coercively redistributed. This is arguably a result of inflation, which the Journal
of Economic Dynamics and Control
(http://www.sciencedirect.com/science?_ob=ArticleURL&_udi=B6V85-4JHMRPH1&_user=741313&_rdoc=1&_fmt=&_orig=search&_sort=d&view=c&_acct=C000041138&_version=1&_u
rlVersion=0&_userid=741313&md5=39873c44f35d619c3be8ee02885283ba) says may alter income,
earnings, or wealth distributions. This is because newly created money often enters the economy at specific
points rather than blanketing society evenly. Furthermore, different people spend money on different things,
and economic stance often has a large impact on where that money is put. As stated in the article, “Inflation
as Income Distribution (http://fee.org/articles/tgif/inflation-as-income-distribution/), “The additional quantity
of money does not find its way at first into the pockets of all individuals; not every individual of those
benefited first gets the same amount and not every individual reacts to the same additional quantity in the
same way.”
Therefore, someone who has very little money could gain from monetary action, but they would need
to use it to pay off necessities; while someone rich could use those gains to save and become richer. So,
while monetary policy can sometimes help all classes, it seems that the rich benefit more in the long-run.
Recall that I discussed GINI coefficients – here is a table of them http://stats.oecd.org/WBOS/Index.aspx?&QueryId=11353&QueryType=View
Can we blame the current recession on monetarism, and will we see less advocacy for monetarism in
the future?
As discussed in class today, there has been a serious and extended fight between monetarists and
Keynesian economists. Herr Professor General Parks even described this dispute by saying that monetarists
won many battles but Keynesian economists won the war. The principle claims against the monetarists stem
from their advocacy of deregulating the market which according to critics, led to the shady credit and the
subprime mortgage crises.
According to one blogger, however, this recent return to Keynesianism reflects political aspirations
rather than belief in Keynesianism over monetarism. The blogger attributes Obama’s moves to expand
regulation and spend more to curb unemployment as products of his identity as a politician. Because the
economy is bad and people are accusing monetarist policies of producing and maintaining these crises,
Obama has moved towards Keynesianism in a big way. Furthermore, he states: “Looking ahead, the fact that
Mr Obama is taking an active role in the economic crisis could inspire the self-confidence needed to shake
recession, which means that even though financial stimulus may have no real economic benefit, people
believing that it does could, on its own, be beneficial. When the American economy finds its way back to
growth—and it will—Mr Obama and his Keynesian policies will probably be credited, and Mr Freidman will
turn in his grave.” (http://www.killerbuffalo.com/2009/04/why-keynesian-solutions-work-a-monetaristsperspective/).
In contrast with a central critique of monetarist policy as the reason for the current recession, Richard
Posner of the Wall Street Journal seems to be critiquing the low-interest policies of the Fed under Greenspan
as a major cause for bank instability as interest rates began to rise in the early 2000s
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(http://online.wsj.com/article/SB124165301306893763.html). Posner explains: “In fact, (housing) prices
were rising because interest rates were low. So when the Federal Reserve (fearing inflation) began pushing
interest rates up in 2005, the bubble began leaking air and eventually burst. It carried the banking industry
down with it because banks were so heavily invested in financing houses.” (Posner is a federal judge – 7th
district court of appeals- and a lecturer at the University of Chicago. He might be the most cited legal
scholar ever with over 40 books and possibly 300 articles.)
So, while hindsight may be 20/20, there is definitely blame to be had by monetarists for this crisis
but, it is not sufficient to point to deregulation as the only reason for the current recession. However,
because of the negative attention given to monetarist policies, I think we can definitely expect much less love
for these theories in the future, especially if President Obama’s
How/can the Phillip’s curve predict a period of inflation or deflation and is it an accurate measure?
Why?
As learned in class, the Phillip’s Curve represents the inverse relationship between inflation and the
unemployment rate. While in the 1950s and 1960s economists thought the Federal Reserve just needed to
pick a point on the curve and the rest would adjust, in reality the Phillip’s curve does not work that way. The
curve is best at graphing a relationship between inflation and unemployment rates in the economy when
inflation is low and unemployment is low (usually on a short run graph). The curve “showed the rate of
wage inflation that would result if a particular level of unemployment persisted for some time”
(http://www.econlib.org/library/Enc/PhillipsCurve.html).
While in the 50s and 60s there appeared to be a relationship shown on the curve, once we hit the
1970s the short – run graph barely seemed to depict a relationship between inflation and unemployment.
The curve looked more like a box shape rather than a curve, and one could no longer be derived from it – a
spiral pattern emerged in the Phillip’s curve. While there is now a defined difference between the long –
term and short –term Phillip’s curve, it has been agreed upon that there is no correlation between
inflation and unemployment. The short run relationship between inflation and unemployment seems to
work because people (economists) are somewhat able to determine what the inflation expectations will be;
however, over time it is more difficult because inflation is dependent upon the previous years’ and the
current state of the economy. It is said that if one expects inflation, they may in turn create inflation.
During the 1970s, it was decided that “the earlier assumption that the historically estimated
Phillips curve represented a rather stable relationship proved to be grossly inaccurate,” therefore
making the Phillip’s curve less reliable (http://www.auburn.edu/~johnspm/gloss/phillips_curve). As
explained earlier, in the past forty years or so, the Phillip’s curve no longer looks like a curve, but rather a
scribble on a the graph and is more in the shape of a box.
Question:
What are these limitations [of the Phillips Curve], and is it possible for more complex
models to account for them?
Since its development by A. W. Phillips in 1958, and its subsequent refinement by Samuelson and
Solow a few years later, the Phillips curve has been a central part of how economists have approached
applying the theory of macroeconomics through monetary policy. This is because the Phillips curve was
believed to show the possible non-neutrality of money, as well as provide a gauge for the threat of inflation
given how fast an economy is growing—which is implicitly measured through the unemployment rate.
The Phillips curve describes a statistical relationship that would appear to encompass the complex
interactions between policy decisions and the behavior of individuals within the economy. The refinement in
the Phillips curve made by Samuelson and Solow was to look at the relationship between price level inflation
and unemployment. The original form of the Phillips curve modeled a presumed relationship between
wage inflation and unemployment. When their version of the Phillips curve was published, Samuelson
and Solow were careful to acknowledge that model did not describe a permanent relationship between price
level inflation and unemployment.
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Instead, the model was presented as an “array of possibilities facing the economy in ‘the years just
ahead’”. This view held by Samuelson and Solow would seem to indicate that both were aware of some
limitations that were innate even within their refined Phillips curve. These limitations arose from the
belief that inflation and the economic frictions that prevented inflation and money from being neutral were in
part structural, meaning they were perceived to be “hard-wired into the institutions of modern, corporate
capitalism”. The paper about the refined Phillips curve by Samuelson and Solow concluded with a
discussion on possible institutional reforms that could shift the Phillips curve down and to the left.
The monetarist Milton Friedman further amended the analysis of the Phillips curve by putting
an emphasis on the effects of the public’s expectation for inflation. Friedman argued that monetary
policy effectively determined the placement of the Phillips curve between the axes for inflation and
unemployment. A consequence of this effect of monetary policy on the Phillips curve was that the
monetary policy actually determined the prevailing rate of inflation. Friedman believed that “the ability
of a small increase in inflation to stimulate economic output and employment relied on the element of
surprise”. In this sense neglecting how the public’s expectations for inflation was originally a downside to
the formation of the Phillips curve.
As an analysis and predictive tool, the Phillips curve is only one equation in a system of equations
that constitute a larger macroeconomic model. A complete equilibrium analysis of an economy’s
performance requires three parts in order to determine the pertinent economic variables and how they have
changed over time. These three required parts are the Phillips curve, the demand side, and the central bank
behavior. In this sense the more simplistic relation between price level inflation and unemployment
expressed in the Phillips curve is actually incorporated into more complex macroeconomic models.
Lacker, Jeffrey M., and John A. Weinberg. "Inflation and Unemployment: A Layperson's Guide to the
Phillips Curve." Economist's View: "Inflation and Unemployment: A Layperson's Guide to the Phillips
Curve" 23 June 2007. Federal Reserve Bank of Richmond Annual Report. 3 June 2009
<http://economistsview.typepad.com/economistsview/2007/06/inflation-andu.htmlhttp://economistsview.typepad.com/economistsview/2007/06/inflation-and-u.html
If the Phillips Curve is only a relative measurement, can it really be accurate in determining the
relationship between unemployment and inflation?
The Phillips Curve actually cannot accurately measure the relationship between unemployment and
inflation. Not only does the original Phillips Curve model not fit actual data, but newer versions of the model
show that an increase in inflation can only lower unemployment in the short run, but not the long run.
As a general rule, many of these economic models only work in theory but not in the real world.
Economics is a social science. Like physics, many of the principles in economics don’t actually exist in the
real world. Economics tries to make sense of the world of money and business. However, even in theory, the
Phillips Curve is a little too simplistic and not adequate enough to explain things, which is why there have
been modified versions of the model.
An article about the Phillips Curve in the New York Times discusses how the model isn’t really an
accurate forecast: “Today, however, the Phillips Curve is missing. All of a sudden economists are a lot less
useful as forecasters. For as it stands now, economists' forecasts of economic growth, unemployment and
inflation are no longer projections based on historical patterns but instead pure guesses based on gut feelings
about when, how, and if the Phillips Curve will return. If they are to be of any use for forecasting, they need
to come up with a better--and probably more complex--theory of under what conditions inflation is likely to
rise.”
It goes on to affirm that even though many economists don’t really believe that the Phillips Curve is
the most accurate model, they still believe that there is a model represented by the model: “At some primal
level, all economists still believe in something like a Phillips Curve. All believe that unemployment will
fall if demand expands faster than the economy's long-run productive capacity. And all believe that if
demand keeps on expanding faster than the economy's long-run productive capacity then, in the long
run, inflation will rise. It was just that the natural rate of unemployment--the signal that this long run had
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arrived--had fallen mysteriously far and mysteriously fast. But, truth be told, the Phillips Curve has not
worked well outside America. Economists Doug Staiger, Mark Watson, and Jim Stock pointed out in the
Journal of Economic Perspectives that even in the United States the Phillips Curve relationship was never as
strong or as good at forecasting inflation as was taught in intermediate macroeconomics. And only in the
United States has there been a relatively stable natural rate of unemployment to serve as a reliable indicator
of when demand pressure is about to raise inflation. Elsewhere the causes of rising inflation have always
been too complex to be summarized by simply comparing unemployment to even a semi-stable
"natural rate."
Wouldn’t the pursuit of one goal aggravate the problem of the other? Are the two goals mutually
exclusive? In regards to China’s economy, should one goal take priority over the other?
“In response to China’s inflation, Chinese officials stated the need to both stimulate consumer spending and
decrease inflation.”
 China’s consumer prices rose 1 percent in January, the slowest in 30 months.
 Producer prices accelerated their fall by 1.1 percent in December to 3.3 percent in January.
In response to these statistics:
 “Policymakers should seize this chance of low inflation to unleash the potential of Chinese
consumers by promptly bringing in place all needed measures to improve domestic consumption
environment.”
Low inflation and price stability will be important for China’s sustained consumption boom. The two
goals do not appear to be mutually exclusive, although stimulating consumer spending appears to take
priority.
Stimulating consumer spending
Increasing domestic consumption or consumer spending would decrease China’s dependence
on exports. (I read somewhere that Chinese economic growth was 80% domestic and only 20% export
led. Alas, I can not find that article) The Chinese save 50 percent of their incomes on average. If they
saved less and consumed more, more production would be consumed domestically. This would allow China
to become less vulnerable to economic recessions abroad. One method of stimulating domestic consumption
is to strengthen the Yuan to decrease the real cost of goods and services within the country.
Decreasing inflation
A stronger Yuan would put downward pressure on inflation. This would again allow Chinese
consumers to buy more goods and services.
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Mild, benign deflation would “help to ease cost burdens for producers and cheaper products may spur
consumption and sustain growth.” The risk would be falling into malign deflation and incurring falling
margins and increasing unemployment. Li Wei, an economist at Standard Chartered Bank in Shanghai says,
“A worst-case scenario for deflation would see producers cutting prices, suffering lower margins and
slashing wages, which would eventually damp consumption.”
Sources
1. http://www.asiasentinel.com/index.php?option=com_content&task=view&id=1206&Itemid=32
2. http://seekingalpha.com/article/69789-china-s-rmb-and-contradictory-policies-on-inflation-andunemployment
3. http://www.ritholtz.com/blog/2009/05/china-consumer-spending-vs-savings/
4. http://www.chinadaily.com.cn/bizchina/2009-02/11/content_7465951.htm
5. http://www.bloomberg.com/apps/news?pid=20601091&sid=aT4MshPZjLoY&refer=india
Question: What changes, if any, have been made to the Phillips curve model to more accurately place
an economy on the curve since the 1970s, given that in class the argument was made that the economy
was initially incorrectly placed on the curve? If no changes have been made, why has the Phillips curve
as a whole become obsolete rather than being amended?
The Phillips curve is a graph that illustrates the inverse relationship between inflation and the
unemployment rate. In the 1950s and 1960s, many economists believed that all the Federal Reserve or the
government had to do was to pick the point on the short-run Phillips curve where they wanted the economy
to be positioned. Less unemployment mean more inflation, and more unemployment meant less inflation.
However, during the 1970s, the Phillips curve faced numerous challenges.
By 1971, the Phillips curve had shifted outward. Years of creeping inflation had destroyed the
Federal Reserve’s credibility as an “inflation fighter?. This led to a rise in expected inflation. In 1973, a
tripling of the world oil prices caused a further outward shift of the Phillips curve. By 1975, the short-term
inflation and unemployment tradeoff became an unfavorable decision. In order to keep unemployment down
at around 5%, inflation would have to be at 12%, a very high percentage. In order to reduce inflation to 3%,
the unemployment rate would have to rise to 10%. During the 1970s and the early 1980s, the short-run
relationship between inflation and unemployment laid out by the Phillips curve seemed to break down.
However, economists were able to salvage the Phillips curve by realizing that there was a significant
difference between the short-run and long-run relationships between inflation and unemployment.
However, despite being reconstructed in the 1970s, the Phillips curve relationship was once again
suspiciously absent during the 1990s. The Phillips curve is still currently today subject to much critique and
criticism. There are two main viewpoints on the relevance of the Phillips curve. Some say that the
relationship between inflation and unemployment has disappeared altogether. Others say that special
circumstances such as the increase in labor productivity account for the lack of a relationship. They believe
that the Phillips curve relationship will return once these factors have subsided. Over the years, the
consensus has developed that the Phillips curve is not a reliable tool to forecast inflation or unemployment.
Question: Can we blame the current recession on monetarism, and will we see less advocacy for
monetarism in the future?
As we begin to emerge from the rubble created by the current recession, many are still searching for
the cause of the current recession. Although there is no unanimous pick for the smoking gun, there are a
significant amount of people who blame monetarism for the economic collapse. For some, connecting the
dots between monetarism and economic failure is easy, for “When the Reagan Republicans, egged on by
Alan Greenspan and the Monetarists of the Chicago School, started to, and nearly succeeded in,
eliminating all government regulation, with the help of Moderate Democrats like Bill Clinton, the
eventual fall of the economy was set in place. And here we are today.”
http://www.capitolhillblue.com/node/18013 Because there was a prevailing belief that free market capitalism
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was the ideal approach to economics, and Greenspan enthusiastically believed in this, a hands off approach
was utilized when dealing with the banks etc.
There is also belief that “Low inflation targeting throughout the developed world has caused this
debacle. That has been the core macroeconomic policy in place informally since 1979, when it was called
monetarism, the implicit objective of which was very low inflation, and formally since 1992 as part of the
Maastricht Convergence Criteria in the EU. The US has just adopted it formally. That low inflation target
caused real interest rates to be held far too high from 1986 to 2000, leading geometrically towards deflation.
Dollar pegs haven't helped, but they are comparatively an irrelevance.”
http://www.telegraph.co.uk/finance/comment/edmundconway/5395530/Financial-crisis-We-must-mend-ourways-not-make-more-rules.html (The last quote was posted as a comment by one David Goldsby – who
knows who he is or whether his opinion is worth something or not – I for one do not know whether
real interest rates were held too low. We could take nominal interest rates and subtract inflation rates
for an approximation of real rates.
14
10
12
8
10
6
8
4
6
4
2
2
0
Jan-1982
0
Jan-1982
Jun-1987
Dec-1992
Jun-1998
Nov-2003
May-2009
Sep-1984
Jun-1987
Mar-1990
Dec-1992
Sep-1995
Jun-1998
Mar-2001
Nov-2003
Aug-2006
-2
-2
-4
-4
-6
-6
3MonAv
30YrAv
InflationAv
3MonReal
15
30YrReal
yearly average of monthly
9
10
7
5
5
3
0
Jan-1982
Sep-1984
Jun-1987
Mar-1990
Dec-1992
Sep-1995
Jun-1998
Mar-2001
Nov-2003
Aug-2006
1
Jan-1982
-1
Sep-1984
Jun-1987
Mar-1990
Dec-1992
Sep-1995
Jun-1998
Mar-2001
Nov-2003
Aug-2006
-5
-3
-10
-5
3MonReal
30YrReal
3MonRealAv
30YrRealAv
Maybe Goldsby means non US real interest rates or maybe he did someother calculation (3 month
treasury rate minus the yearly inflation rate) or maybe he just made the fact from his head.
In lieu of the recession, however, many are clamoring that “we must overhaul financial regulation,
create a centralized market for the financial instruments behind so much of the trauma, find a more sensible
way of dealing with collapsed investment banks and collect more information on hedge funds.”
http://www.telegraph.co.uk/finance/comment/edmundconway/5395530/Financial-crisis-We-must-mend-ourways-not-make-more-rules.html
Regardless of the finger-pointing, “Capitalism has come under scrutiny during previous periods of
economic turbulence,” and it has continually reemerged. Furthermore, there is also a large camp of
individuals who blame Keynesian policies for the collapse, meaning that the debate between monetarists is
far from over and monetarism has not been written off. Surely though, deregulation was in many ways to
blame for the current recession. Whether or not this recession is evidence of a failed entire economic model
has yet to be determined. For now, the advocacy for monetarism will probably dwindle.