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Monetarism Notes

Monetarism Notes. Econ 102 Mr. Smitka Winter 2003. Prime Minister Kakuei Tanaka, 1972 田中角栄. 列島改造計画 Plan to Rebuild the Japanese Archipelago Slowdown ca. 1970 encouraged fiscal policy

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Monetarism Notes

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  1. Monetarism Notes Econ 102 Mr. Smitka Winter 2003

  2. Prime Minister Kakuei Tanaka, 1972田中角栄 • 列島改造計画 Plan to Rebuild the Japanese Archipelago • Slowdown ca. 1970 encouraged fiscal policy • Tanaka started in the construction industry, used that to raise campaign funds for faction / political party • 1971 ¥/$ appreciation: end of “Bretton Woods” • huge inflow of dollars, bought to lessen forex shift but boosted money supply / lowered interest rates • Sum: both stimulative MP and stimulative FP • Double-digit inflation by 1973

  3. Oil Crisis • October 6, 1973 Yom Kippur War • OPEC already more active • Boom not just in Japan but also US, Europe • I worked overtime, 7 days / week, at UAW wages … • Demand made cartel discipline moot • Oil prices quadrupled • Japan imported 99+% of oil • Huge boost in inflation • Inflation jumped to 25% • Panic buying: shoppers trampled to death buying TP

  4. Bank of Japan reaction

  5. Analytic issues • Time lags • Recognition • Implementation • Impact • Time consistency • Short-run versus long-run • Structural issues • Institutional change renders historical relationships (model parameters) misleading

  6. Monetarist models • MP = ? … what should be goals? • MV  PY … an identity: true by definition • M is money stock • V is velocity, ability of a given amount of money to support economic activity • P is price level, Y real GDP • So PY is nominal GDP • Can this framework be used?

  7. MV  PY • IF velocity “V” is stable • AND the link between nominal and real GDP is predictable • THEN can tie changes in money supply to changes in “P” – that is, inflation • But in fact • V is noisy and shifts with institutional change • PY is not easy to decompose

  8. Sample arithmetic • MV  PY…to use, add growth rates • M plus 5% • V ±2% since volatile / large error component • Then PY can range from +7% to +3% • Real Y avg +2% but can fall as much as -1% • [increase can be more short-run, coming out of recession] • So P can range from: • 7% - (-1%) = 8% • 3% - 2% = 1% • Monetarist framework offers little insight under “normal” growth rates of US and post-1973 Japan

  9. Sample arithmentic #2 • M = +25% • V ±2% as before • Then PY can range from 27% to 22% • Even with real Y = +5% inflation is high • But oil crisis ---> Y = -2% [or worse!] • So inflation 24% ≈ 29% • High “M” growth is indicative of problems

  10. Other aspects • FP side effects • Implications of lifetime consumption model • MP side effects • Do you really want low investment to persist? • Are big swings in forex rates desirable? • International side effects • How to respond to exogenous forex shifts?

  11. Calulation • Nominal change x = new value is (1 + x) times old • Ditto inflation π ==> new value is (1 + π) old • Hence the net change is:1+x = 1 + x - π (+ error term) 1+π • Hence real change ≈ x - π • This approximation is accurate when x & π are single-digit

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