The myth was peddled by (of all people!) the British Labour politician James Callaghan (UK Prime Minister from 1976 to 1979) when in 1976 he declared that Keynesianism “only worked on each occasion ... by injecting a bigger dose of inflation into the economy, followed by a higher level of unemployment as the next step,” before he introduced at least a rhetorical commitment to a pre-Thatcherite form of monetarism in the UK.
But it is nonsense, certainly in the case of the US, as we can see in the graph below.
There were two outliers: the post-WWII inflation and the Korean War inflation. But, apart from these, the inflationary spike that did break out after 1968 was unusual and a deviation from the basic price stability of the golden age. That price stability was most notable for the late 1950s and most of the 1960s. In fact, actual deflation briefly occurred twice in the post-WWII era.
As Nicholas Kaldor long ago noted, during the golden age “for a long time the rate of inflation (as measured by consumer prices) remained moderate, and until the closing years of the 1960s it showed no clear tendency to acceleration” (Kaldor 1976: 214).
The reason for the inflationary crisis of the 1970s was four-fold:
(1) From 1968–1971 there were the beginnings of inflationary pressures, in both wages and prices in many industrialised nations. The fundamental cause was that around 1968–1969 in Japan, France, Belgium and the Netherlands and from 1969–1970 in Germany, Italy, Switzerland and the UK wage rises had occurred, which Kaldor attributes to strong action by unions (Kaldor 1976: 224). There is a perpetual struggle between capitalists and labour over distribution of income, and it just happened that around 1968 to 1970 labour won out in many countries causing a bout of cost-push inflation (via wage increases). But this would not have become a serious problem had it not been for factors (2), (3), and (4).The unfortunate concatenation of these historically unprecedented shocks – that is, factors (1), (2), (3), and (4) – in toto was the cause of 1970s stagflation.
(2) the dismantling of commodity buffer stock policies that had previously ensured price stability. The prelude to stagflation was marked by a significant explosion in commodity prices that occurred in the second half of 1972. Part of the problem was the failure of the harvest in the old Soviet Union in 1972–1973 and the unexpectedly large purchases on world markets by the Soviet state. This could have been averted had the United States not dismantled its commodity buffer stock policies in the 1960s.
(3) The end of Bretton Woods (the post-WWII international monetary system) was momentous: inflationary expectations and instability on financial and commodity markets resulted, as well as a rise in commodity speculation as a hedge against inflation. This contributed to the cost-push inflation that was being felt in many countries after 1971.
(4) The final factor that caused the severe inflation of the 1970s was the first oil shock from October 1973, when various Middle Eastern producers of oil instituted an embargo that lasted until March 1974 (Kaldor 1976: 226). In most countries, the double digit inflation of the 1970s was caused by the oil shocks (both the first and second).
Kaldor stresses the importance of factor (2). During most of the golden age of capitalism (1945–1973), primary commodity buffer stocks had created stable prices. But this policy was changed in the 1960s when the US modified its buffer stock policies:
“… the duration and stability of the post-war economic boom owed a great deal to the policies of the United States and other governments in absorbing and carrying stocks of grain and other basic commodities both for price stabilisation and for strategic purposes. Many people are also convinced that if the United States had shown greater readiness to carry stocks of grain (instead of trying by all means throughout the 1960s to eliminate its huge surpluses by giving away wheat under PL 480 provisions and by reducing output through acreage restriction) the sharp rise of food prices following upon the large grain purchases by the U.S.S.R. [in 1972–1973], which unhinged the stability of the world price level far more than anything else, could have been avoided.” (Kaldor 1976: 228).That was a major factor causing stagflation, along with wage–price spirals. The first oil shock was a final factor that exacerbated everything.
BIBLIOGRAPHY
Kaldor, N. 1976. “Inflation and Recession in the World Economy,” Economic Journal 86 (December): 703–714.
Yep. But politicians wanted a simple narrative and economists wanted a simple model. To put it another way: in the confusion, the idiots won the day. Funny how that happens when there's an uptick in inflation and apart from that things aren't actually that bad, but when you have a massive financial crisis and protracted stagnation the idiots maintain the reins on power.
ReplyDeleteWhat you are saying here is that inflation during a time when Keynsianism was the predominate economic framework was caused by a string of things over which economic policy makers apparently had no control.
ReplyDeleteI think that this highlights that when Keynesian say things like
"Monetary policy is a highly variable and blunt instrument. The relationship between interest rates and output is complex and not linear: the monetary transmission between interest rates and real economic variables is unreliable and complicated. It might work or might not. It depends on the state of expectations." (To quote a comment from LK on a differences thread)
They are in effect saying that they don't understand money and monetary policy and can't be held responsible when they support policies that fail to prevent inflation.
At the heart of Keynesian thinking is the need to manage AD. But as the theory does not provide a good way of determining what the "correct" level of AD is they have to target real things like employment or GDP growth. When these things move below their target values (for example due to a supply shock) then Keynesian policies dictate that AD needs to be boosted. A correct monetary theory will explain why this is inflationary.
In a similar way - if a rate of employment above the natural equilibrium rate is targeted then again monetary theory will explain why this leads to inflation. It is rather ironic for Keynsians to claim that this kind of inflation is caused by the workers having too much power when the very Keynesian policy of maintaining unnaturally high employment levels is the main factor leading to that empowerment.
So when Keynesian blame external factors for inflation they are in effect admitting they have a framework that cannot deal with external shocks in a way that is not inflationary.
(1) "What you are saying here is that inflation during a time when Keynsianism was the predominate economic framework was caused by a string of things over which economic policy makers apparently had no control."
DeleteI am saying nothing of the sort. See (4) below.
(2) "At the heart of Keynesian thinking is the need to manage AD. But as the theory does not provide a good way of determining what the "correct" level of AD is they have to target real things like employment or GDP growth. "
If this is intended as some refutation of Keynesianism, it is a bizarre statement.
Fiscal policy is used manage employment and real output, yes. Why should there be some universal, single correct level of AD at all times? All economies are different and change over time
The low levels of unemployment and strong real GDP growth tell you when expansionary fiscal policy is not needed, when you have the correct level of AD..
(3) "In a similar way - if a rate of employment above the natural equilibrium rate is targeted then again monetary theory will explain why this leads to inflation."
There is no such thing as a natural rate of unemployment. It is a neoclassical myth.
(4) "So when Keynesian blame external factors for inflation they are in effect admitting they have a framework that cannot deal with external shocks in a way that is not inflationary."
I strongly suspect you have not paid the slightest attention to the argument of this post.
Commodity buffer stocks and the use of those stocks to control inflation in the prices of factor inputs IS the major "framework" or method to "deal with external [inflationary] shocks".
That was why the golden age had price stability.
The second method is incomes policy to control excessive wage rises, and rein in wage-price spirals.
Incomes policy is also a policy of Post Keynesian economics.
And before I get the absurd but "wage-and-price-controls-never-work" mantra, the widespread and very prevalent use of administered pricing and fixprice markets already should show anyone who thinks about it that policies to control factor input costs and wages should have a very significant influence on prices in fixprice markets.
There's a difference between something being indeterminate and not being properly understood. If you recognise something as being indeterminate and this is in fact the case then you do understand it -- i.e. you understand it as being indeterminate.
DeleteIts a very old fashioned view to think that something needs to be conceived mechanistically and perfectly deterministically in order to be properly "understood". Outside of some types of theology and crude genetic theories of evolution, that mindset largely died out in the late-nineteenth century.
By the way, sort of funny to see an Austrian economist complaining about indeterminacy in the Post-Keynesian theory of interest rates. Methinks you should perhaps be weeding your own backyard with those criticisms:
Delete"To acknowledge the unknowability of the future is to acknowledge the essential indeterminacy and uncertainty surrounding human existence. But surely in doing so we
need not consign human existence to wholly uncoordinated chaos. To speak
of entrepreneurial vision is to draw attention, by use of metaphor, to the
formidable and benign coordinative powers of the human imagination.
Austrian economists have, in principled fashion, refused to see the world as wholly knowable, as suited to interpretation by models of equilibrium from which uncertainty has been exhausted." ('Uncertainty, Discovery and Human Action', Krizner, Israel)
On 1 and 4: You seem to just be saying that these buffers would have prevented this particular kind of supply shock while my point is that a good economic framework will deal generically with any supply shock in a way that does not boost inflation expectations.
ReplyDeleteon 2 and 3: I guess that as you don't recognize that there is an equilibrium rate of anything that an economy might seek out if allowed to then economics does indeed come down to a central planner choosing the desired rate of growth and employment and using fiscal policy to achieve it, then using price controls (and other regulations) if this proves inflationary. Can't really argue with that.
On 1 and 4
DeleteWell, my response is: both the neoclassical and Austrian "economic frameworks" are wrong, so I dispute that either would "deal generically with any supply shock in a way that does not boost inflation expectations."
But, out of sheer curiosity, what is your "economic framework"?
Are you a Misesian, Hayekian, neoclassical or what?
on 2 and 3:
You might find market-clearing prices in *some* flexprice markets. Clearance sales approach to some degree the idea of market clearing, but hardly perfectly.
But there is no reason to believe that the idea that a universal set of market clearing prices exists just waiting to be discovered by tatonnement ine very market. That is a quasi-religious superstition.
E.g., Steve Keen -- citing and using the findings of just mainstream, higher level neoclassical research literature -- demonstrates how the law of demand can be proven only in the case of a single consumer (Keen, Steve. 2011. Debunking Economics: The Naked Emperor Dethroned? (rev. and expanded edn). Zed Books, London and New York. p. 51). Nor can we generalise the law of demand and prove that it necessarily applies to a whole market either (Keen, ibid). A market demand curve “can take any shape at all – except one that doubles back on itself” (Keen, ibid, p. 52).
No neoclassical -- or anyone else for that matter -- can prove that the "law of demand" is universally true even in an abstract form.
By the time you get to the messy and complex real world, there is certainly no reason to believe it.
On interest rates, Keynes already showed that reductions in interest rates to stimulate investment and consumption have variable effects, because of expectations. Add to that problems when the private sector is deleveraging and already saturated with private debt.
The economists I mostly agree with include Steve Horwitz , George Selgin and Leland Yeager but I try to keep an open mind.
DeleteSo in other words you draw on the economic thought of the free bankers and GMU Austrians? -- which on the face of it is actually the superior Austrian camp.
DeleteI assuming, then, that you:
- do not oppose fractional reserve banking as inherently fraudulent and support free banking
- do not endorse anarcho-capitalism but support some minimal night watchman state? (or am I wrong)
- have some sympathy with the monetary disequilibrium/equilibrium theory
- might endorse NGDP targetting as apparently some GMU Austrians do?
Right on all 4 counts - though I have some concerns around the last one.
DeleteBTW: "the United States dismantling its commodity buffer stock policies in the 1960s"
ReplyDeleteactually counts as a supply shock in a proper economic theory !
So, what, you are conceding that golden age buffer stock policies caused price stability in key factor inputs?
DeleteDon't know enough about it - sounds like it would smooth out price fluctuations in the short-term but I don't see how it would avoid underlying price changes from eventually emerging.
Deleteoh you mean magical price changes due to the heavens that cannot be controlled by man? Oh, right, THOSE.
Delete"That was a major factor causing stagflation, along with wage–price spirals"
ReplyDeleteJust as neo-liberals say - are guilty too high wages of workers.
Look at the NGDP growth rates for OECD countries in the 1970's, they were way above normal. NGDp is a measure of the circulating money supply, which causes demand pull inflation. Cost-push inflation was there , with the oil shocks. but cost-push can't be ongoing without government restrictions on making and producing the supply in question. If those restrictions exist, its the governments fault. (But not the central bank part) If supply side restrictions do not exist, and NGDp growth is unusually high relative to trend, that tells you that there is
ReplyDeletedemand side inflation and the central bank is at FAULT.
EITHER WAY THE GOVERNMENT IS ALWAYS AT FAULT. I would modify Friedman's saying a bit. Sustained inflation is always and everywhere a government phenomenon.
"There is no such thing as a natural rate of unemployment. It is a neoclassical myth."
(Facepalm) There is no such thing is frictional unemployment, the natural amount of people who change jobs every year, even in a booming economy.? If you were to say that the natural rate is lower than what central banks nowadays think it is, then yes you would have a point. But to deny its existence is sheer lunacy. Another thing. It DOESN"T HAVE TO BE CONSTANT.
"NGDp is a measure of the circulating money supply, which causes demand pull inflation"
DeleteOnly in a world of universal or mainly flexprice markets at full employment or without excess capacity.
You have ignored -- like any Austrian -- the widespread existence of fixprice markets, and a world of unused excess capacity in industries and plants.
Furthermore, money supply increases are mostly a consequence of economic activity. Not the other way round.
"There is no such thing is frictional unemployment, the natural amount of people who change jobs every year, even in a booming economy"
You should know well that is not how neoclassicals define the natural rate of unemployment.
Their definition is: the rate that would exist consistent with a constant rate of inflation.
You Really ignore things that contradict your worldview, don't you? Fascinating. Just to make things interesting, Im reposting the answer I gave you a while back on why Monetary policy is better than fiscal for stimulating the economy.
ReplyDelete"Previous thread continued
"Fine. You think QE needs to be tens of trillions.
Given the US economy is about $15 trillion, would you say $20 trillion or $30 trillion is the appropriate level of QE?
Why not just spend 2-3 trillion in the form of stimulus over a few years on badly need public infrastructure?
"
yes I think 20 trillion, or the credible threat to do it, would be sufficient.
And you ask a very, very, GOOD question about infrastructure. Its why Im a Friedmanite rather than a Keynesian.
Its simple, Infrastructure spending and AD boosting work at cross purposes. Its like mixing oil and water. When you build needed infrastructure, the aim should be to provide a high quality public product at the lowest possible price, (a bridge in an economically significant and populated area that'll enhance productivity, and reduce travel times, etc.
Whereas when we have an AD problem, as we do now, the larger the stimulus, the more money is spent the more people are put back to work, which is the whole aim of stimulus, NOT to build a high quality product. Its more expensive, and time consuming in terms of real resources too, whereas MP involves pushing buttons on a computer screen.
If we need infrastructure, fine, but don't call it demand stimulus call it supply stimulus. Eisenhower's interstate highway system was not built during the depression, it was built during the 50's a prosperous time if I recall for the American economy. Tax levies should be used, mixed with bond issues, and perhaps public private partnerships.
Bottom line AD and AS problems are substantially different and we shouldn't confuse them
I forgot to add,
monetary policy reduces the public debt burden, whereas fiscal policy, (assuming its financed with bonds and not treasury printing) increases it.
If the Fed buys $10 trillion of Treasurys worldwide, thats $10,trillion less the US government has to pay, and the interest is also remitted back to the US Treasury department too."
First, this comment has virtually nothing to do with my post above.
DeleteBut you say:
"Whereas when we have an AD problem, as we do now, the larger the stimulus, the more money is spent the more people are put back to work, which is the whole aim of stimulus, NOT to build a high quality product"
Not to build a high quality product, you say? I would like to see you actually prove this statement.
First, the private sector is perfectly capable of building something of poor or medium quality.
Secondly, obviously through the Western world during public works stimulus the government DOES contract put a good many things to the private sector which already undermines your argument, unless you're saying the private sector is inferior.
""There is no such thing is frictional unemployment, the natural amount of people who change jobs every year, even in a booming economy"
ReplyDeleteYou should know well that is not how neoclassicals define the natural rate of unemployment.
Their definition is: the rate that would exist consistent with a constant rate of inflation. "
That's the NAIRu, LK!
I have ignored nothing about fixprice markets. Fixprice markets are not frozen forever. they are reset at regular intervals, if not day by day, then month by month. Your comment about excess capacity is generally true though In assumed you knew this. I would quibble with you and say that There is a slight uptick of inflation even when there is unused execs capacity that is being put back to work, because of expectations effects.
An the endogenous money supply responds to changes in the exogenous one, not the other way around. There is no guarantee that the government will actually meet its obligations to accommodate the increased demand for money.
"First, this comment has virtually nothing to do with my post above."
Given the fact that you ignore evidence that doesnt fit into your worldview, I feel obligated to challenge you, and keep old threads alive, even if they may not be exactly on topic. :-)
"Not to build a high quality product, you say? I would like to see you actually prove this statement.
"
Ok.
In an economic depression, Most Keynesians say that money has to be quickly spent on the unemployed to put people back to work, right? Delaying for months, trying to get engineers, or constructions workers, trying to find the tools to build the shovel ready products. This takes time. time the unemployed dont have. Its cheaper quicker, IN TERMS OF REAL RESOURCES IN THE ECONOMY, for the fed to buy bonds, or if you must do FS, give workers an immediate payroll tax cut, which affects everyone, and not just the politically connected.
"First, the private sector is perfectly capable of building something of poor or medium quality."
I didn't say otherwise. Although those businesses that do this tend to go out of business. Whereas government agencies ask for more money.
"Secondly, obviously through the Western world during public works stimulus the government DOES contract put a good many things to the private sector which already undermines your argument, unless you're saying the private sector is inferior."
See above
"In an economic depression, Most Keynesians say that money has to be quickly spent on the unemployed to put people back to work, right? Delaying for months, trying to get engineers, or constructions workers, trying to find the tools to build the shovel ready products."
DeleteWhat happens in the REAL WORLD is that governments carry out extensive studies and planning of public infrastructure deciding what is useful, necessary and the best way to do it BEFORE recessions happen.
They have a list of things that can be done, which is then implemented during a recession.
That is the meaning of "shovel ready" projects.
NAIRU is simply the natural rate stripped of any inconvenient assumptions which can be attacked. Whereas Friedman's natural rate specified that accelerating inflation was required to push unemployment down due to trade unions, minimum wage laws etc., NAIRU simply states that pushing unemployment down past the non-accelerating rate generates accelerating inflation, without attempting to explain why or quantify the effect.
DeleteNAIRU is a myth, it's a crock. There is a huge body of evidence now that poses considerable challenges at both the both the theoretical and empirical levels for those who adhere to the NAIRU hypothesis. Here is a summary of the Non-NAIRU facts.
Delete1-Unemployment rates exhibit high degrees of persistence to shocks.
2-The dynamics of the unemployment rate exhibit sharp asymmetries over the business cycle. There is mounting evidence against the dynamics implied by the NAIRU approach Unemployment responds to demand shocks in an asymmetrical manner. The unemployment rate rises quickly and sharply when demand contracts but persists and falls slowly when expansion occurs.
3-Inflation dynamics do not seem to accord with those specified in the NAIRU hypothesis. Reconsider the graphs and table above to see this point.
4-The constant NAIRU has been abandoned and replaced by so-called Time-varying-NAIRUs (just another ad hoc fudge), which have such large standard errors. The NAIRU-concept is now all but meaningless for policy analysis. The majority of econometric models developed to estimate the NAIRU are mis-specified and deliver very inaccurate estimates of the NAIRU. Most of the research output confidently asserted that the NAIRU had changed over time but very few authors dared to publish the confidence intervals around their point estimates. I note that the TRYM documentation does indicate how unreliable their estimates are in statistical terms. One major study used so-called “state-of-the-art” estimation techniques and said their NAIRU estimates were imprecise. In 1994, for example, some of the 95 percent confidence intervals around the NAIRU estimates ranged from of 2.9 percent to 8.3 percent. So this range of uncertainty about the “true” value of the NAIRU is too large to be useful.
5-Estimates of steady-state unemployment rates are cyclically-sensitive (hysteretic) and thus the previously eschewed use of fiscal and monetary policy to attenuate the rise in unemployment has no conceptual foundation.
6-There is no clear correlation between changes in the inflation rate and the level of unemployment, such that inflation rises and falls at many different unemployment rates without system.
7-The use of univariate filters (Hodrick-Prescott filters) with no economic content and Kalman Filters with little or no economic content has rendered the NAIRU concept relatively arbitrary. Kalman Filter estimates are extremely sensitive to underlying assumptions about the variance components in the measurement and state equations. Small signal to noise ratio changes can have major impacts on the measurement of the NAIRU. Spline estimation is similarly arbitrary in the choice of knots and the order of the polynomials. Why not ask yourself: what caused the sudden arbitrary jump in the TRYM estimate in the last graph around 1974? They haven’t a coherent explanation. It is just a data fudge.
Source: http://modernmoney.wordpress.com/2011/02/21/nairu-is-a-myth/