DYNAMIC MONETARY THEORY AND THE PHILLIPS CURVE WITH A POSITIVE SLOPE ADRIÁN RAVIER

1. APPE International Conference, Maui, Hawaii, April 14-16, 2013. Rosario, sábado 7 de agosto de 2010 DYNAMIC MONETARY THEORY AND THE PHILLIPS CURVE WITH A POSITIVE SLOPE ADRIÁN RAVIER aravier@ufm.edu

2. APPE International Conference, Maui, Hawaii, April 14-16, 2013. Rosario, sábado 7 de agosto de 2010 Abstract Don Bellante and Roger W. Garrison (1988) compared two alternative approaches to monetary dynamics: those based on a vertical long-run Phillips Curve and those derived from analysis of Hayekian triangles. The conclusion the authors reached is that the only factor differentiating the two models is the “process” whereby the initial cause is converted into the final “neutral” effect. This article refutes that conclusion. To do so it suffices to demonstrate that the long-term effect of monetary policy is never neutral. While it is true that after the boom-bust cycle the economy returns to the natural rate of unemployment, the crucial point is that the ‘natural rate’ at the end of the cycle is quite different from the one evident at the start. This requires an ‘Austrian’ Phillips Curve with a positive slope.

3. Part I: The debate over the Phillips Curve.

4. APPE International Conference, Maui, Hawaii, April 14-16, 2013. Rosario, sábado 7 de agosto de 2010 Alban William Housego Phillips (1914-1975) Source: “The relation between unemployment and the rate of change of money wage rates in the United Kingdom, 1861-1957” A. W. H. Phillips (1958)

5. APPE International Conference, Maui, Hawaii, April 14-16, 2013. Rosario, sábado 7 de agosto de 2010 The Phillips Curve and the Economic Cycles • “These conclusions are of course tentative. There is need for much more detailed research into the relations between unemployment, wage rates, prices and productivity” Source: “The relation between unemployment and the rate of change of money wage rates in the United Kingdom, 1861-1957” A. W. H. Phillips (1958)

6. The contribution of Paul Samuelson and Robert Solow APPE International Conference, Maui, Hawaii, April 14-16, 2013. Rosario, sábado 7 de agosto de 2010

7. Rate of Price Change 1dp P dt A Unemployment APPE International Conference, Maui, Hawaii, April 14-16, 2013. Rosario, sábado 7 de agosto de 2010 0 UL U0 UH The Keynesian Phillip`s Curve with a negative slope • ELEMENTS • Short Run oriented approach • The Non-Neutrality of Money in the Short-Run • The stabilizaing effect of monetary policy • Implications for policymakers

8. APPE International Conference, Maui, Hawaii, April 14-16, 2013. Rosario, sábado 7 de agosto de 2010 The refutation of the Phillips Curve • There were three events which were imposed against the hypothesis of Phillips´s trade off. • The first was represented by the general theoretical reaction against the Keynesian system, both by the monetarists led by Milton Friedman, and also by the Austrian economists led by Friedrich A. von Hayek. • The second was that the model, although well adapted for the study of Samuelson-Solow (1960), failed in its application to other economies. • And third, the emergence of the process of "stagflation," understood as a phenomenon of high inflation and high unemployment simultaneously.

9. Rate of Inflation 1dp P dt APPE International Conference, Maui, Hawaii, April 14-16, 2013. Rosario, sábado 7 de agosto de 2010 H I B ( 1dp )** = B P dt G A F ( 1dp )* = A P dt E UL UN ( 1dp ) = 0 P dt Unemployment Monetarist counter-revolution: Expectations-Adjusted Phillips Curve • ELEMENTS • Natural Rate of Unemployment (NAIRU) • Monetary Policy short-run effects (accepts the keynesian view) • Adaptive expectations • The lag in monetary policy. Clearly distinguish the short-long run effects. • Quantity Theory of Money and the Principle of Neutrality of Money • M V = P y • Real Wages versus Nominal Wages • Acceleration of inflation theory • Implications for policymakers

10. Part II: The Bellante-Garrison comparison

11. APPE International Conference, Maui, Hawaii, April 14-16, 2013. Rosario, sábado 7 de agosto de 2010 The Bellante-Garrison Comparison • In general, Monetarists have taken comfort in the Knightian view that the structure of capital, particularly the inter-temporal structure, can be safely ignored, and that theories in the Austrian tradition, which make use of such concepts as ‘roundaboutness’ and ‘stages of production,’ are especially misguided. (Bellante and Garrison, 1988: 208)

12. The Bellante-Garrison Comparison APPE International Conference, Maui, Hawaii, April 14-16, 2013. Rosario, sábado 7 de agosto de 2010 • Five points of commonality are noteworthy: (1) Both theories can be fully squared with the kernel of truth in the quantity theory of money. (2) Both theories deal with disequilibrium phenomena, but neither denies that equilibrating forces dominate in the end. (3) Both hinge in a critical way on the distinction between short-run effects and long-run effects. (4) Both involve a market process that is necessarily, or endogenously, self-reversing. Monetary disturbances cause certain kinds of distortions in market signals. These distortions give rise in the short run to movements in certain prices and quantities, movements which in the long run create market conditions for counter-movements in those same prices and quantities. (5) With appropriate qualifications (about what constitutes the long-run) both theories are characterized by monetary disturbances whose short-run effects are non-neutral but whose long-run effects are neutral” (emphasis added).

13. Part III: The positive slope of the Phillips curve

14. Milton Friedman: A positively sloped Phillips Curve? APPE International Conference, Maui, Hawaii, April 14-16, 2013. Rosario, sábado 7 de agosto de 2010 • “In recent years, higher inflation has often been accompanied by higher not lower unemployment, especially for periods of several years in length. A simple statistical Phillips curve for such periods seems to be positively sloped, not vertical.” • Milton Friedman (1976) • INFLATION AND UNEMPLOYMENT IN SEVENT COUNTRIES, 1956-1975. Note: DP is rate of change of consumer prices compounded annually from calendar year 1955 to 1960; 1960 to 1965; 1965 to 1970; 1970 to 1975. M is average unemployment during five indicated calendar years. As a result, DP is dated one-half year prior to associated M.

15. A positively sloped Phillips Curve? APPE International Conference, Maui, Hawaii, April 14-16, 2013. Rosario, sábado 7 de agosto de 2010 • According to the five year averages in the Table, the rate of inflation and the level of unemployment moved in opposite directions-the expected simple Phillips curve outcome – in five out of seven countries between the first two quinquennia (1956-60, 1961-65); in only four out of seven countries between the second and third quinquennia (1961-65 and 1966-70); and in only one out of seven countries be-tween the final two quinquennia (1966-70 and 1970-75).

16. A positively sloped Phillips Curve? APPE International Conference, Maui, Hawaii, April 14-16, 2013. Rosario, sábado 7 de agosto de 2010 • The averages for all seven countries plotted in Figure 3 bring out even more clearly the shift from a negatively sloped simple Phillips curve to a positively sloped one. The two curves move in opposite directions between the first two quinquennia; in the same direction thereafter.

17. A positively sloped Phillips Curve? APPE International Conference, Maui, Hawaii, April 14-16, 2013. Rosario, sábado 7 de agosto de 2010 • The third stage is directed at accommodating this apparent empirical phenomenon. To do so, I suspect that it will have to include in the analysis the interdependence of economic experience and political developments. It will have to treat at least some political phenomena not as independent variables - as exogenous variables in econometric jargon - but as themselves determined by economic events – as endogenous variables [...]. The third stage will, I believe, be greatly influenced by a third major development - the application of economic analysis to political behavior, a field in which pioneering work has also been done by Stigler and Becker as well as by Kenneth Arrow, Duncan Black, Anthony Downs, James Buchanan, Gordon Tullock, and others. (Milton Friedman, 1977, p. 470)

18. A positively sloped Phillips Curve? APPE International Conference, Maui, Hawaii, April 14-16, 2013. Rosario, sábado 7 de agosto de 2010 • In my doctoral thesis (Ravier, 2010), I called this “Friedman´s dilemma” because Friedman observed an empirical reality his own analytical framework was unable to explain. Friedman observes a positively sloped Phillips curve and a long term effect of monetary stimulus which is not neutral in real terms. Both are inconsistent with his own theories. Instead he provides evidence confirming the work of Robert Lucas (1973) and, more recently, William Niskanen (2002). Robert Mulligan (2011) has demonstrated the connection between Niskanen’s article and Austrian Business Cycle Theory.

19. S “Natural” Unemployment W/P Minimum Wage APPE International Conference, Maui, Hawaii, April 14-16, 2013. Rosario, sábado 7 de agosto de 2010 W/P* D Qd Qs Even though Milton Friedman developed this concept with Wicksell's “natural rate of interest” in mind, it is important to recognize that there is really nothing 'natural' about this special rate of unemployment.This ‘natural’ rate has several implicit precursors, such as labor legislation (especially the minimum wage), the monopoly power of unions, and efficiency wages, all of which represent rigidities in the labor market. In the absence of these labor market rigidities, full employment would be the true ‘natural’ rate. This is the familiar textbook example showing the impact of a minimum wage set above the actual market wage, causing disequilibrium or unemployment. (Mankiw, 2001, p. 162) This is what Friedman calls ‘natural unemployment’, determined by local characteristics or other structural rigidities in the labor market. Labor Market and “Natural” Unemployment

20. Monetary Policy and Less Unemployment in the Short-Term S Less Unemployment W/P Minimum Wage W/P* APPE International Conference, Maui, Hawaii, April 14-16, 2013. Rosario, sábado 7 de agosto de 2010 D’ D Qd Qd’ Qs From this point, we consider the impact of expansive credit policy and its impact on the labor market following a sequence of steps consistent with Austrian Business Cycle Theory. Unemployment is reduced, at least temporarily.

21. Capital Destruction and More Unemployment in the Long-Term APPE International Conference, Maui, Hawaii, April 14-16, 2013. Rosario, sábado 7 de agosto de 2010 S New Natural Unemployment W/P Minimum Wage W/P* W/P** D D’ Qd’ Qd Qs It is at this point that the divergence of opinion occurs. Austrians explain that due to the mal-investment process during the stimulus phase we also face a situation in which the potential productive capacity of the economy is reduced as a consequence of the “partial destruction of capital”. That destruction inevitably occurs because there is a category of resources which are lost when investment projects are abandoned.

22. A Phillips Curve with a Positive Slope: A possible solution to Friedman´s Dilemma APPE International Conference, Maui, Hawaii, April 14-16, 2013. Rosario, sábado 7 de agosto de 2010 • Accept the keynesian thesis in the short-run, which we think is compatible with ABCT Inflation rate • Partially accept the monetarist theory in the sense that the initial short run effect is reversed in the long run. G p4 F • However, we propose some differences, that can be reduced to three debates: p3 E D 1. The Non-Neutrality of Money in the Long-Run p2 C B p0 A 2. Subjective Expectations versus adapative and rational expectations B* p1 U1 U2 U3 U4 Unemploy- ment rate 3. The Austrian Business Cycle Theory U* Deflationrate Frictional Unemploy- ment Real Wage Rigidity and Structural Unemployment CAPITAL THEORY

23. Conclusions

24. A Phillips Curve with a Positive Slope: A possible solution to Friedman´s Dilemma APPE International Conference, Maui, Hawaii, April 14-16, 2013. Rosario, sábado 7 de agosto de 2010 • Accept the keynesian thesis in the short-run, which we think is compatible with ABCT Inflation rate • Partially accept the monetarist theory in the sense that the initial short run effect is reversed in the long run. G p4 F • However, we propose some differences, that can be reduced to three debates: 20016-17??? p3 E D 1. The Non-Neutrality of Money in the Long-Run 2008 p2 C B 2001 p1 A 2. Subjective Expectations versus adapative and rational expectations B* p0 U1 U2 U3 U4 Unemploy- ment rate 3. The Austrian Business Cycle Theory U* Deflationrate Frictional Unemploy- ment Real Wage Rigidity and Structural Unemployment CAPITAL THEORY

25. Inflation rate G p4 F p3 E D p2 C B p1 A Rate of Inflation B* p0 U1 U2 U3 U4 Unemploy- ment rate U* Deflationrate Frictional Unemploy- ment Real Wage Rigidity and Structural Unemployment 1dp P dt APPE International Conference, Maui, Hawaii, April 14-16, 2013. Rosario, sábado 7 de agosto de 2010 H I B ( 1dp )** = B P dt G A F ( 1dp )* = A P dt E UL UN ( 1dp ) = 0 P dt Unemployment Rate of Price Change 1dp P dt A Unemployment 0 UL U0 UH Thank you!