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New Developments in the theory of inflation. Jacques SAPIR, PhD. Professor of Economics, EHESS-Paris Director CEMI-EHESS -Paris Lecture 1. The classical Theory of Inflation. The historical debate. The monetarist counter-revolution and beyond.

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new developments in the theory of inflation

New Developments in the theory of inflation

Jacques SAPIR, PhD.

Professor of Economics,


Director CEMI-EHESS -Paris

Lecture 1. The classical Theory of Inflation.
      • The historical debate.
      • The monetarist counter-revolution and beyond.
  • Lecture 2. Microeconomic Foundations of the « standard » theory and critics.
      • Standard microeconomics.
      • Standard microeconomics contested.
  • Lecture 3. The classical Theory contested.
      • Facts and figures.
      • Theoretical critics.
  • Lecture 4. Toward a new synthesis.
      • Theoretical crisis and paradigm shifts.
      • Model of inflation with sticky information and a new Synthesis.
  • Lecture 5. A new model of inflation and its policy implications.
      • Aims for a new model of dual-inflation
      • Policy implications.
short bibliography
Short bibliography
  • 1. From the lecturer.
    • In Russian
      • J. Sapir K Ekonomicheskoj teorii neodnorodnyh sistem - opyt issledovanija decentralizovannoj ekonomiki, Moscow, 2001, (p. 122-139).
      • J. Sapir, “ Stabilizacija i perehodnyj period: francuzkaja tochka zrenija na hod i rezul’taty reform v Rossii”, in V. Ivanter et J. Sapir (edits.), Denezhnye i Finansovye Problemy Perehodnogo Perioda v Rossii: Rossijsko-Francuzkij Dialog, Nauka, Moscou, juin 1995, pp. 266-301.
      • J.Sapir, "Novye podhody teorii individual'nyh predpotchenij i ee sledstvija" in Ekonomitcheskij Zhurnal, Vol. 9, n 3/2005, pp. 325-360.
      • J. Sapir, "Kakim dolzhen byt' uroven' infljacii? (O znatchenii davnykh diskuccij dlja opredelenija segodnjachej strategii razvitija Rossii)" in Problemy Prognozirovanija, n3/2006, pp. 11-22.
    • Other languages
      • J. Sapir, "Russia's Crash of August 1998: Diagnosis and Prescriptions", in Post-Soviet Affairs, vol. 15, n1/1999, January-March, pp. 1-36.
2. Other Authors.
    • J.M.Keynes, "A tract on Monetary reform" (1926), in J.M.Keynes, Essays in Persuasion, Rupert Hart-Davis, London, 1931.
    • D. Patinkin, “Walras’Law” in J. Eatwell, M. Milgate et P. Newman (Edits.), General Equilibrium - The New Palgrave, Macmillan, Londres, 1987.
    • J. Tobin et K. Buiter, "Long-run effects of fiscal and monetary policy on aggregate demand", in J. Stein (ed.) Monetarism, North Holland, Amsterdam, 1976, pp. 273-319.
    • F. Hahn, "Monetarism and Economic Theory", in Economica, vol. 47, n1/1980, pp. 1-17.
    • B.S. Bernanke et F.S. Mishkin, "Inflation Targeting: A New framework for Monetary Policy" in Journal of Economic Perspectives, vol. 11, n1/1997, pp. 97-116.
    • G.A. Akerlof, W.T. Dickens et G.L. Perry, "The Macroeconomics of Low Inflation" in Brookings Papers on Economic Activity, n 1/1996, pp. 1-59.
    • T.M. Andersen, "Can Inflation Be Too Low ?" in Kyklos, vol. 54/2001, Fasc.4, pp. 591-602.
    • B.C. Greenwald et J.E. Stiglitz, "Toward a Theory of Rigidities" in American Economic Review, vol. 79, n2, 1989, Papers and Proceedings, pp. 364-369.
    • J. Furher et G. Moore, "Inflation Persistence" in Quarterly Journal of Economics, vol 110, n1/1995, pp. 127-160.
    • G.N. Mankyw et R. Reis, "Sticky Information versus Sticky Prices: A Proposal to Replace the New Keynesian Phillips Curve" in Quarterly Journal of Economics, vol. 117, n4/2002, pp. 1295-1328
lecture 1 the classical theory of inflation part 1 the historical debate
LECTURE 1The classical Theory of InflationPart-1: The historical debate
  • Say ’s equality and uncertainty.
      • Say’s microeconomics.
      • Say versus Cantillon.
  • Revisiting Cantillon
  • How Walras « liquidated » money and inflation.
      • Walras’ Law and monetary equilibrium.
      • Walrasian equilibrium and Barter Trade
  • Inflation as ‘ class struggle ’ (not who you would think at first…actually Max Weber and J.M. Keynes).
      • Weber’s theory of monetary prices.
      • Keynes and the social dimension of inflation and deflation (1924).
Inflation as a microeconomic process: von Hayek (1932).
  • The ‘ demand for money ’ theory: from Wicksell to Keynes ’ Treatise on Money (1930).
      • Wicksell and the two rates of interest theory (monetary equilibrium IS NOT general equilibrium).
      • Keynes’ theory of the demand for money.
        • Trading
        • Insurance
        • Speculation
      • Keynes and the “Liquidity Trap”.
      • Gunnar Myrdal and the “ex-ante” vs “ex-post” interest rate.
      • Georges Shackle and the post-Keynesian synthesis: liquidity is related to uncertainty.
        • The Unexpected and the Counter-expected.
        • Keynes and Cantillon: a new view on the liquidity trap.
part 2 the monetarist counter revolution and beyond
Part-2The ‘ monetarist counter-revolution ’ and beyond
  • Rational expectations and ‘ demand for money ’.
      • Why would “rational agents” keep their assets liquid ?
      • The Bomol-Tobin interpretation of the demand for money function.
  • The Friedman synthesis: permanent income and money neutrality.
      • What is the “permanent income”.
      • The long-term neutrality assumption and Friedman’s arguments against the Phillips Curve.
      • Money creation as an exogeneous process.

The price to unemployment relation controversy




Of the price

to unemployment







Robert Lucas theory of money: the birth of the « new-classical school ».
      • Methodological rejection of uncertainty.
      • Perfect substitution of wealth assets.
      • Rational expectations and government policy.
  • Microeconomic foundations and macroeconomic implications.
      • No “monetary illusion”
      • Inflation is a pure monetary phenomenon.
      • Iliquidity is Insolvency.
  • The ‘ standard ’ theory of inflation by early 90 ’s.
      • Money does not create wealth so restrictive monetary policies can’t destroy wealth.
      • Assets mobility prevents local rents under restrictive monetary policies.
      • “0” inflation is the best target.
Lecture 2Microeconomic Foundations of the « standard » theory and critics.Part-1: Standard microeconomics
  • The “rational individual agent” : main axioms
      • (a) Individual preferences:
        • Complete pre-ordering of preferences implying transitivity and reflexivity.
        • Preferences are continuous (no discrete choice).
        • Non-saturation of individual preferences.
      • (b) The Subjective Expected Utility Assumption.
        • Preferences are to be independent (if x>y>z, then any mix (x,z) generates an utility greater than any mix (y,z)).
        • Temporal monotony and Temporal integration.
      • (c) Rationality is maximising the SEU
Rational choice as a global explanation.
      • Gary Becker and the society as a sum of “rational choices”
      • The Permanent Income theory as SEU maximization.
        • U inc = f (m, B, St, Fcap, Hcap), where m is total monetary assets, B total wealth in bonds, St total wealth in stocks, Fcap total wealth in fixed capital and Hcap wealth in human capital.
        • All capital assets are generating an income flow which is (a) computable and (b) probabilistic.
  • The “Hard Budget Constraint” Theory.
      • A basic assumption (the “budget constraint”).
      • Kornaï and an institutionnalist approach of microeconomic behaviours.
        • Institutions generate the budget constraint.
        • Agents adapt to the budget constraint?
      • Implications for macroeconomic dynamics and inflation.
      • Implies that Liquidity = Solvency (which is true under perfect information…)
part 2 standard microeconomics contested
Part-2: Standard microeconomics contested
  • The Allais paradox (Maurice Allais, 1953).
      • Why preferences instability?
      • The “common consequence” problem.
  • Rational choice under uncertainty: Herbert Simon.
      • Cognitive saturation.
      • Routines vs Innovation.
      • Procedural vs Substantive rationality, and Keynes’ preference for liquidity.
  • Reversal of preferences (Slovic, Lichtenstein).
      • The Allais’ Paradox revisited.
      • Problems in gambling.
      • Non-transitivity in preferences.
The new context-dependent theory of individual preferences (Tversky and Kahneman).
      • The “Endowment Effect”
      • The “Framing Effect”
      • Preferences as a constructive, context-dependant process (Tversky & Thaler: A. Tversky et R. Thaler, "Preference Reversals", Journal of Economic Perspectives, vol. 4/1990, p. 201-211)
      • Back to Keynes and Max Weber?
  • What rationality is?
      • Contextual rationality.
      • Substantive rationality as a specific case.
      • Switch between models of rationality.
      • Limits of axiomatic reasoning.
lecture 3 the classical theory contested part 1 facts and figures
Lecture 3The classical Theory contestedPart-1: facts and figures.
  • The classical theory meets its match.
      • Russia vs China.
      • Indonesia vs Malaysia.
      • Japan’s deflation in the 90’s.
      • EU inflation diversity.
  • Traditional stabilisation success stories revisited.
      • How Israel was stabilised in the 80’s.
      • How Jeffrey Sachs did not stabilise Bolivia.
      • Are lessons of hyperinflation stabilisation relevant for stabilising “simple” inflations.
The “core inflation” phenomenon.
      • What is “core inflation”?
      • How much for a “core”: US and European experiences.
      • Why “core inflations” are not the same?
      • Could “core inflation” be significant: France and Italy in the 50’s and the 60’s.
part 2 theoretical critics
Part-2: Theoretical critics.
  • G. Akerlof and the “too low inflation” paradigm.
      • Wages rigidity.
      • Rigidity and Uncertainty
      • Rigidity and Competition: strategic behaviour.
      • The “nominal debt” effect and the return of the monetary illusion.
      • A model of the US economy, 1925-1990.
  • The price rigidities explanation.
      • Monetary prices and relative prices. Why a changing economy “needs” inflation: the “Hayekian Inflation” paradigm.
      • Prices indexation and the technical chain paradigm: a model of technically induced inflation propagation.
      • Prices and industrial branches specificity: differences in decision temporality and pricing behaviour.
The “output gap” notion.
      • What the “output gap” is.
      • Non-neutrality of money.
      • Measuring the output gap.
  • Microeconomic explanations.
      • Constructive preferences (Framing and Endowment effects).
      • Asymetric information and the “nothing to loose” behaviour.
      • Cognitive saturation (and procedural rationality).
lecture 4 toward a new synthesis part 1 theoretical crisis and paradigm shift
Lecture 4.Toward a new synthesis.Part-1: Theoretical crisis and Paradigm shift
  • Theoretical crisis from the mid-90’s on.
      • Traditional “monetarist” models have logical inconsistencies, detected as early as 1971 by Frank Hahn.
      • “New-Classical” models (R. Lucas) imply no uncertainty and Lucas himself has been disenchanted with them.
      • Models with random price adjustment (Calvo and Taylor) also called models with “neo-Keynesian Phillips curve” are generating counter-factual results.
      • New-Keynesian models (models with nominal rigidities as the Akerlof-Dickens-Perry) are proving much better to simulate actual economic movements.
      • “Standard” macroeconomics unable to explain actual life dynamics and unable to cope with advance in microeconomics.
Paradigm shifts:
      • Stabilisation policies can be harmful.
      • Deflation is worse a threat than inflation in some case (Japan).
      • Inflation is to be “targeted” more than fought to the finish.
      • Growth is as important than price stability (relevance of the output gap).
      • Economics need a more realistic description of the individual agent, including cognitive limitations.
      • Money is NOT neutral.
part 2 model of inflation with sticky information and the new synthesis
Main assumptions:

Price adjustments are not optimal through lack of time to process information.

Strong follow-the-leader process among enterprises in the same sector.

Strong strategic complementarity among different sectors

(variables in log)

p(t) = f (p(t-n))

Spontaneous indexation effect

p(xi) = f (p (xL) )

Monopolistic pricing even in a competitive market.

p (xA) = f (p (xB) )

Cross-sectoral indexation.

Part-2: Model of inflation with Sticky Information and the new synthesis
gregory mankew and ricardo reis models keynesian dynamics from former monetarist authors
Microeconomic price setting function:

p*k = p + ak x + E k

p = ∑ (t ki * p ki )


p*k = standard price growth in sector k

p = CPI

ak = sector k sensibility to the global business cycle.

x = output gap

EK = endogeneous shocks in sector k


Strong inertial component, not linked to market imperfections in inflation dynamics (up to 7 quarters).

Strong negative effect of stabilisation policies on output.

Adjustment to the output gap at the enterprise level could generate effects leading to more inflationary pressures.

There is a minimum threshold for inflation in each economy, and it is > 0.

Gregory Mankew and Ricardo Reis models: Keynesian dynamics from former monetarist authors...
Is a new Synthesis in the coming?
      • Sticky Information models demonstrate that “typical” Keynesian results can be generated from the new-classical framework IF more realistic assumptions are made.
      • Sticky Information models (Mankew and Reis) and new-Keynesian ones (Akerlof-Dickens-Perry) are converging on the same set of results and prescriptions.
      • Advance in microeconomics (cognitive saturation, information asymmetry, constructive and context-dependent preferences) are destroying most of the Monetarist counter-revolution foundations.
      • Consistency between microeconomics and macroeconomics IS needed and IS possible.
  • But would this synthesis be enough?
and now coming next and soon
And now, coming next and soon...
  • Lecture 6: A two sectors model of dual inflation.
      • Presentation of the model.
      • Resolution and variants.
  • Lecture 7: Estimating the structural inflation dimension.
      • Western Europe 1950-1980.
      • Russia 2000-2008.
  • Lecture 8: Is there a financial dimension in inflation.
      • The financial system as a constraint.
      • Financial bubbles and Asset Prices inflation.
  • Lecture 9: Dual inflation in an open economy.
      • Competitiveness and the change rate issue.
      • Regional currency agreements under fire (the Euro).
  • Lecture 10: Toward new macroeconomic policies.
      • What stabilisation is (short-term vs. long-term).
      • Developing effective financial systems.