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Monetarist vs. Austrian Views of the Trade Cycle The Many Faces of Monetarism. Friedman’s Monetarism: M V = P Q With a mild upward trend in velocity and Output (Q) growing slowly, the price level (P) moves with the money supply (M). with a lag of 18-30 months. Friedman’s Monetarism:

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Monetarist vs. Austrian Views of the Trade Cycle The Many Faces of Monetarism

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Monetarist vs austrian views of the trade cycle the many faces of monetarism

Monetarist vs. Austrian

Views of the Trade Cycle

The Many Faces of Monetarism


Monetarist vs austrian views of the trade cycle the many faces of monetarism

Friedman’s Monetarism:

M V = P Q

With a mild upward trend in velocity

and Output (Q) growing slowly,

the price level (P) moves with the money supply (M).

with a lag of 18-30 months.


Monetarist vs austrian views of the trade cycle the many faces of monetarism

Friedman’s Monetarism:

M V = P Q

Friedman’s Monetarism:

M V = P Q

Friedman’s Monetary Rule:

Increase the money supply at a slow and steady rate so as to achieve long-run price-level constancy.

with a lag of 18-30 months.


Monetarist vs austrian views of the trade cycle the many faces of monetarism

--from J. Bradford DeLong’s “The Triumph of Monetarism?”

Journal of Economic Perspectives, Winter 2000.

The velocity of money became unstable after 1980.

Friedman’s policy rule lost its velocity anchor.

The Federal Reserve abandoned money-supply targeting in favour of interest-rate targeting.


Monetarist vs austrian views of the trade cycle the many faces of monetarism

Friedman’s Monetarism:

M V = P Q

with a lag of 18-30 months.

The Irony of Monetarism:

The monetary rule that allows the economy to perform at its laissez-faire best presupposes a critical piece of intervention (Regulation Q) that makes the money supply operationally definable.


Monetarist vs austrian views of the trade cycle the many faces of monetarism

Friedman’s Monetarism:

M V = P Q

with a lag of 18-30 months.

Greenspan: “We don’t know what money is, anymore.”

…which explains why the Federal Reserve switched from money-supply targeting to interest-rate targeting in the early 1980’s


Monetarist vs austrian views of the trade cycle the many faces of monetarism

Friedman’s Monetarism:

M V = P Q

with a lag of 18-30 months.

Note: Q = QC + QI

but the effect of interest-rate changes on relative movements of consumption and investment and on the pattern of investment is no part of the theory.


Monetarist vs austrian views of the trade cycle the many faces of monetarism

Friedman’s Monetarism:

M V = P Q

with a lag of 18-30 months.

Inflation is always and everywhere a monetary phenomenon.

But what goes on in the short-run---during that critical 18-30 months?


Monetarist vs austrian views of the trade cycle the many faces of monetarism

Rising prices create a discrepancy between

the the real wage rate as perceived by the employer

and the real wage rage as perceived by the employee.

The employer sees the wage rate falling w.r.t output prices.

The employee sees—but only belatedly—the falling real wage.

Initially, the employee sees a rising wage rate.

Real wage (employee’s view)

Real wage (employer’s view)

A Theory of Labor-Market Dynamics


Monetarist vs austrian views of the trade cycle the many faces of monetarism

Short-Run/Long-Run Phillips Curve Analysis

In response to an increase in the money supply, the economy moves up a short-run Phillips curve, but the curve itself shifts as workers straighten out their perceptions of the real wage rate.

The long-run Phillips curve is vertical.


Monetarist vs austrian views of the trade cycle the many faces of monetarism

But note:

A rise in P is prerequisite to a money-induced boom. That is, P must rise, and then be differentially perceived, causing Q to rise.

If P doesn’t rise, then there is no boom. During the 1920s and the 1990s, there was little or no increase in P. And so, the SR/LR Phillips curve story doesn’t apply.

The Mises-Hayek theory applies to these two episodes but Friedman’s theory doesn’t.


Monetarist vs austrian views of the trade cycle the many faces of monetarism

According to SR/LR:

Q rises to the extent that P rises.

But MV=PQ suggests that Q rises to the extent that P does not rise.

Remember, there’s an 18-30 month lag between increases in M and increases in P.

Also, one of the fundamental propositions of monetarism is that when M is increased, Q rises first and P rises hardly at all.


Monetarist vs austrian views of the trade cycle the many faces of monetarism

According to Orthodox Monetarism:

Qrises first.

Q rises as a result of P rising.

Q is unaffected in the long run.

The three claims together suggest a self-reversing process (with a flourish):

In the face of an increased money supply, Q rises as does P, but Q then falls to its initial level as P becomes fully adjusted to the higher M. (During the process, labor-market dynamics can give an extra boost to Q.)


Monetarist vs austrian views of the trade cycle the many faces of monetarism

In response to an increase in the money supply, prices are bid up as people try to purchase more output.

But with no more output to purchase, people buy bonds instead, driving the rate of interest below its equilibrium level.

In the long-run, prices fully adjust to the higher money supply and the interest rate returns to its initial level.

Patinkin’s Model


Monetarist vs austrian views of the trade cycle the many faces of monetarism

According to Patinkin:

Q remains at its full-employment level during the adjustments of the price level and the interest rate.

More specifically, the interest rate falls and then rises as the price level becomes fully adjusted to the higher money supply.

Note that the interest rate is low for a period of 18-30 months without there being any effect on the make-up of output.


Monetarist vs austrian views of the trade cycle the many faces of monetarism

According to alternative constructions:

The level of employment rises and then falls as the economy adjusts to an increase in the money supply, but the rate of interest remains out of play.

The rate of interest falls and then rises as the economy adjusts to an increase in the money supply, but the economy remains at its full-employment level throughout the adjustment.


Monetarist vs austrian views of the trade cycle the many faces of monetarism

About those alternative constructions:

Suppose each is half right.

The rate of interest falls and then rises as the economy adjusts to an increase in the money supply, while at the same time the level of employment rises and then falls.

Wouldn’t the increased labor input be allocated intertemporally in accordance with a relatively low rate of interest?


Monetarist vs austrian views of the trade cycle the many faces of monetarism

Friedman accounts for the M-P lag of 18-30 months:

Holders of cash will…bid up the price of assets. If the extra demand in initially directed at a particular class of assets, say, government securities, or commercial paper, or the like, the result will be to pull the prices of such assets out of line with other assets and thus widen the area into which the extra cash spills. The increased demand will spread sooner or later affecting equities, houses, durable producer goods, durable consumer goods, and so on, thought not necessarily in that order…. These effects can be described as operating on “interest rates” if a more cosmopolitan [i.e., Austrian] interpretation of “interest rates” is adopted than the usual one which refers to a small range of marketable securities.

Milton Friedman (1969 [1961]), “The Lag Effect in Monetary Policy,” in Miltion Friedman, The Optimum Quantity of Money and Other Essays, Chicago: Aldine.


Monetarist vs austrian views of the trade cycle the many faces of monetarism

“The key feature of this process [during which interest rates are low] is that it tends to raise the prices of sources of both producer and consumer services relative to the prices of the services themselves…. It therefore encourages the production of such sources and, at the same time, the direct acquisition of the services rather than of the source. But these reactions in their turn tend to raise the prices of services relative to the prices of sources, that is, to undo the initial effects on interest rates. The final result may be a rise in expenditures in all directions without any change in interest rates at all; interest rates and asset prices may simply be the conduit through which the effect of the monetary change is transmitted to expenditures without being altered at all….”

Milton Friedman (1969 [1961]), “The Lag Effect in Monetary Policy,” in Miltion Friedman, The Optimum Quantity of Money and Other Essays, Chicago: Aldine.


Monetarist vs austrian views of the trade cycle the many faces of monetarism

“It may be … that monetary expansion induces someone within two or three months to contemplate building a factory; within for or five, to draw up plans; within six or seven, to get constructions started. The actual construction may take another six months and much of the effect on the income stream may come still later, insofar as initial goods used in construction are withdrawn from inventories and only subsequently lead to increased expenditure by suppliers.”

Milton Friedman (1969 [1961]), “The Lag Effect in Monetary Policy,” in Miltion Friedman, The Optimum Quantity of Money and Other Essays, Chicago: Aldine.


Monetarist vs austrian views of the trade cycle the many faces of monetarism

Friedman’s

Plucking Model


Monetarist vs austrian views of the trade cycle the many faces of monetarism

The equation of exchange is so near and dear to Milton Friedman’s heart that he

A. has made his wife Rose promise that it will make a tasteful appearance on his headstone.

D. has adopted it as his vanity license plate number for his Cadillac Eldorado.

C. has written a parody to the popular Y.M.C.A to memorialize the equation in song.

B. has had it spelled out in pansies in the flower garden at Stanford’s Hoover Institution.


Monetarist vs austrian views of the trade cycle the many faces of monetarism

The equation of exchange is so near and dear to Milton Friedman’s heart that he

  • tasteful appearance on his head stone.

  • B. spelled out in pansies in flower garden.

  • C. parody to the popular Y.M.C.A.

  • D. vanity license plate number.

Gribouillis économiques


Monetarist vs austrian views of the trade cycle the many faces of monetarism

Monetarist vs. Austrian

Views of the Trade Cycle

The Many Faces of Monetarism


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