Download A post-Keynesian alternative to the New consensus on monetary

A post-Keynesian alternative to the New
consensus on monetary policy
Marc Lavoie
University of Ottawa
What is the New consensus?
• New Keynesian “consensus-type model”,
where policy reaction functions are “an
essential part of the macroeconomic
system”.
• Also called, the New Keynesian Synthesis
• J.B. Taylor, Blinder, D. Romer, Woodford,
Meyer.
How is the New consensus linked to
post-Keynesian theory?
• Positively
• Negatively
• “The main change is
• The New consensus
that it replaces the
reproduces accepted
assumption that the
dogma among
central bank targets the
neoclassical economists,
money supply with an
la pensée unique as the
assumption that it
French say.
follows a simple interest
rate rule” (Romer 2000:
154).
How is the New consensus linked to
post-Keynesian theory ?
(2) About the reaction function
• Post-Keynesians
• There is an interest
rate reaction function
because it cannot be
otherwise. Money
supply targeting is
impossible in principle
and in practice.
• New Consensus
• There is an interest
rate reaction function
because interest rate
targeting is more
successful to dampen
shocks to money
demand than money
supply targeting.
La pensée unique
• Expansionary fiscal policy only leads to
higher inflation rates and higher real interest
rates in the long run;
• More restrictive monetary policy only leads
to lower inflation rates in the long run.
The New Consensus
• “There is substantial evidence demonstrating that
there is no long-run trade-off between the level of
inflation and the level of unused resources in the
economy – whether measured by the
unemployment rate, the capacity utilization rate,
or the deviation of real GDP from potential GDP.
Monetary policy is thus neutral in the long run.
An increase in money growth will have no longrun impact on the unemployment rate; it will only
result in increased inflation.” Taylor 1999
The new consensus: summary
• The new consensus is simply a variant of
monetarism;
• but without any causal role for money.
• It is monetarism without money.
New consensus model
•
•
•
•
•
•
IS function:
g = g0 ! $r + ,1
Vertical Phillips curve
dB/dt = ((g ! gn) + ,2
Central bank reaction function:
r = r0 + "1(B ! BT) + "2(g ! gne)
New consensus model:
An alternative version (Setterfield)
•
•
•
•
•
•
IS function:
g = g0 ! $r + ,1
Vertical Phillips curve
dB/dt = ((g ! gn) + ,2
Central bank reaction function:
dr = "1(B ! BT) + "2(g ! gne)
Implicit to
the New Keynesian model
• A natural real interest rate
• r0 = rn = (g0 ! gn)/ $
• which implies (g ! gn) = $(r – rn)
• A natural growth rate, given by supply-side factors
• gn = a constant
Figure 5: The hidden consensus equation
B
0
gn
gn
Kaldor: The Scourge of Monetarism
Assuming that the behaviour of the `real' economy is
neutral with respect to monetary disturbances, why
should the elimination of inflation be such an
important objective as to be given 'over-riding
priority'? In what way is a community better off with
constant prices than with constantly rising (or falling)
prices? The answer evidently must be that … inflation
causes serious distortions and leads to a deterioration in
economic performance, etc. In that case, however, the
basic proposition that the `real' economy is impervious
to such disturbances is untenable. Pp. 41-42
2000 survey of AEA economists
• Question: Real GDP eventually returns
automatically to potential real GDP?
– Agree: 63 %
– Disagree: 37 %
– Journal of Economic Education, Fall 2003
2000 survey of AEA economists
• Question: There is a natural rate of
unemployment to which the economy tends
in the long run ?
– Agree: 68 %
– Disagree: 32 %
r
Figure 1: The graphical new consensus with
T)
r
=
r
+
"
(B
!
B
0
1
r
RF


MP
IS
B
B
g
B


AD
B
Start with the historically given rate of inflation
gn
g
Figure 2: New consensus with rising MP curve
r
r
RF
MP


IS
B
B
B

g

AD
B
gn
g
Figure 3A: Impact of a rise in effective demand:
There is a lag in inflation
r
r
r3
RF
r1
B
A

MP

IS
B
B
g
B
B3
B1


B
A
IA
AD
B
gn
g2
g
Figure 3: Impact of a rise in effective demand
r
r
r3
RF
r1
C
A

B


MP
IS
B
B
g
B
B3
B1


C

B
A
IA
AD
B
g3=gn g2
g
Figure 4A: Bringing back inflation to its target rate
r

RF4

r4
r3
D
C

r1

B


MP
A
IS2
RF1
IS1
B
B
B
B3
g
D

BT
B

A
g4
C

gn

B
g2
IA
AD2
AD1 AD4
g
Figure 4: Bringing back inflation to its target rate
D
r

RF4

r4
r3
D
C

r1

B


MP
A
IS2
RF1
IS1
B
B
B
B3
g
D

BT
B

A
g4
C

gn

B
g2
IA
AD2
AD1 AD4
g
Post-Keynesian alternatives
• (1): Reject the vertical Phillips curve and
replace it with a long-run downwardsloping Phillips curve (Setterfield) or a flat
Phillips curve (Kriesler-Lavoie)
• Or,
• (2) Endogenize the natural rate of growth gn
(Lavoie)
Similarity with PK critique of
natural rate of unemployment
• Hargreaves-Heap (Economic Journal 1980)
• Cottrell (JPKE, 1984-85)
• dUn /dt = N(U ! Un) + ,3
Post-Keynesian views
• “Disequilibrium adjustment paths can affect
equilibrium outcomes” (Colander, 1996:
60), leading to multiple equilibria and to
path-dependent equilibria.
• “The natural rate of growth is ultimately
endogenous to the demand-determined
actual rate of growth” (Setterfield, 2002: 5)
Post-Keynesian views II
• “Neoclassical growth economists on the one
hand, ... treat the rate of growth of the
labour force and labour productivity as
exogenous to the actual rate of growth....
• Economists in the Keynesian/postKeynesian tradition, ... maintain that growth
is primarily demand driven because labour
force and productivity growth respond to
demand growth” (León-Lesdema and
Thirlwall, 2002).
2000 survey of AEA economists
• Question: Changes in aggregate demand
affect real GDP in the short run but not in
the long run ?
– Agree: 62 %
(potential growth is given)
– Disagree: 38 % (potential growth is affected
by short-run effective demand)
The alternative PK model
g = g0 ! $r + ,1
dB/dt = ((g ! gn) + ,2
r = r0 + "1(B ! BT) + "2(g ! gn)
r0 = rnT = (g0 ! gn)/ $
dgn /dt = N(g ! gn) + ,3
PK model becomes a system of two
differential equations
 dg / dt 
 dg / dt 
 n


  (1   2  )   1 

1   2



  (1   2  )   1 
1   2





  3   2  (d 1 / dt ) 
g  

1   2
g   

 n 
3


PK model becomes a system of
two differential equations
• The dynamics of this system are pretty
straightforward, because the determinant of
this system is zero;
• and because its trace, is always negative.
• The amended new consensus model
displays a continuum of equilibria. The
model is said to contain a zero root.
• As the long-run equilibrium is not
predetermined anymore, the steady-state
rate of accumulation now depends on
transitional dynamics, which cannot be
ignored: short-run events have a qualitative
impact on long-run equilibria. It is common
to speak of ‘path-dependence’ for such a
characteristic. It is possible to show that this
kind of model displays hysteresis in the
sense of a ‘permanent effect of a transitory
shock’ (Olivier 1999).
An example of hysteresis
• For instance, a temporary increase in the
rate of price inflation that would arise
independently of excess demand pressure
would have permanent effects on the natural
rate of growth and the natural real rate of
interest.
Another example
• Monetary policy now has real effects that
go beyond its impact on the inflation rate.
• Zero-inflation or low-inflation targeting has
a negative impact on the real economy,
bringing in high real rates of interest and
low real rates of growth.
Figure 6: Path-dependence, likely case
gn
dg = 0
dgn = 0
A*
gn
B

E


A
B*
gB gnB gnE gnA gA
g
Figure 8A: Reducing the inflation target: PK model
r
rB
rB *
r
RF2


B

C

rC
rE


E
IS
B
B
g
B
BE

B
BC
AD2

BT
B

E
C
AD

gB
gnC gnE
g
Figure 8: Reducing the inflation target: PK model
r
r
rB
rB *
RF3
RF2



B

B*

C

rC
rE


E
IS
B
B
g
B
BE


B
BC
BT
B


C
E
AD
B*
gB gnB gnC gnE g
Other visual interpretation of hysteresis
Slope is
gn = n + a
Log K
Log qfc
New slope
Actual path
Time
The New Consensus view
Log K
Log qfc
Slope is
gn = n + a
Actual path
Time
A less drastic interpretation of hysteresis, when the
central bank reacts to utilization rates, with
g = gn + µ (u  un)
Log K
Log qfc
Slopes are
gn = n + a
Actual path
Time
Other critiques: IS Curve
Reject the simple interest rate -investment
relation implied in the IS model:
• Central bank sets short term interest rate, but
what about the long term interest rate
which is said to influence investment and
aggregate demand (however do businesses
and households now borrow on a variable
interest rate?)
• Monetary policy is a blunt instrument, with
long and variable lags.
Some additional critiques: Efficacy of
Monetary Policy
•
•
Real interest rate hikes may lead to higher inflation
rates, through interest cost push; it also generates
an additional flow of interest payments in a stockflow consistent model
Empirically, evidence suggests that the interest
elasticity of investment is non-linear and
asymmetric.
Interest rates ↑ → investment ↓ in times of
economic booms, the reverse is not true.
Interest rates ↓ → unlikely investment ↑ in times of
recession.
What about the role of fiscal policy?
• Is counter-cyclical fiscal policy dead?
• What about the US with Reagan and Bush?
• What about Europe and its fiscal constraints
imposed by the Maastricht Treaty (deficit at a max
of 3% of GDP)?
• Is Canada a counter-example of Keynesian
economics (growth picked up when the federal
government cut into its expenditures and raised
taxes)? Is there an explanation of this
phenomenon? (there is!).
The Kriesler/Lavoie Phillips Curve
Inflation rate
ufc : full capacity
utilization
πn : rate of inflation
associated with the
normal range of output
πn
um
Ufc
Rate of capacity
utilization
Post-Keynesian Phillips Curve
In the long run ….
Inflation rate
Utilization rate
um
ufc
Empirical work that gives support to a
horizontal Phillips curve
• Eisner 1995, 1996, identifies a traditional segment,
followed by a flat segment, even with high rates of
utilization
• Filardo, Kansas City Federal Reserve Bank Economic
Review, 1998, has the three segments of PUP.
• Driscoll and Holden (2004).
• Most recent studies at the Bank of Canada cannot find a
relationship between the rate of utilization (or the output
gap) and the inflation rate: the Phillips curve looks
everywhere flat.
• Bloch and al. (JPKE, 2004) pretend that strong world
demand for raw materials is the main source of inflation,
and not domestic demand within each country.
Conclusion:
• Even if natural growth rates are not endogenous, it
is very likely that current monetary policies have
led to overly low rates of utilization and overly
high unemployment rates.
• Central banks tell us that they are doing a good
job. But lower interest rates could have been set,
without inflation rising. In other words, high rates
of capacity utilization may not have the
inflationary effects that central banks presume
they have.
…And this is recognized by some
(previous) central bank officers
• « If expectations of low inflation are firm, and the Phillips curve is
almost flat over a wide range at 2 percent inflation, it may be time to
make monetary policy explicitly accountable for the cyclical
component of output. To implement the idea, following the clause
• “Within this range monetary policy will continue to aim at keeping the
trend of inflation at the 2 per cent target midpoint”
• the official statement could add
• “Monetary policy will seek the maximum levels of output and
employment consistent with this target.” »
• K. Clinton (Bank of Canada 1972-2003), Bordeaux 2006.