Download Monetarism and Post-War Monetary Policy: A Debate on Inflation and Interest Rates and more Slides Banking and Finance in PDF only on Docsity! Monetarism. Monetary policy in post-war period. Limited debate. Practical problems. Beginnings of monetarist critique. Return of macroeconomic turbulence: debate revives. Monetarist theory. Friedman: Quantity Theory of Money restated. Permanent Income Hypothesis. Adaptive Expectations Hypothesis. LR / SR distinction. ‘Natural rate’. Monetary policy ‘in’ the ISLM framework. Money market disequilibrium. Discretionary MP and generation of Cycle. ‘Long and variable lags’. Optimum MS rule. Problems of CB in controlling MS – review and preview. Docsity.com Monetary policy in post-war boom: • High war debts → government aims: – Keep down government’s r repayments – Maintain PB. • Curb effects by ceilings on credit / credit rationing. • Low π: – Fixed ER (Bretton Woods) till early 1970s. – Counter-inflationary policy: ‘prices and incomes policy’ > monetary instruments. • Outcome: Bias towards loose monetary policy. – → Steady build-up of underlying inflationary pressure. Docsity.com •Friedman (1968): ‘twice damned’. •“If liquidity preference is absolute or nearly so – as Keyes believed likely in times of heavy unemployment – interest rates cannot be lowered by monetary measures. •“If investment and consumption are little affected by interest rates… lower interest rates, even if they could be achieved, would do little good. •“Monetary policy is twice damned… •“The wide acceptance of these views in the economics profession meant that for some two decades monetary policy was believed by all but a few reactionary souls to have been rendered obsolete by new economic knowledge.” Docsity.com • Practical problems with post-war UK macro policy: • Balance of Payments / conflict of goals. • £ fixed against $ at rate unchanged for 18 years ($2.80 / £). – This constrained MP: • Expansion [GO!] → BOP deficit: M↑, X↓. – → response: deflation [STOP!] , with goal of: » Imports ↓ » π↓ → export competitiveness↑ • When BOP back to surplus, government would reflate [GO!]. – i.e. ‘stop-go’. Docsity.com Y high BUT: → M↑ and π also high → X↓ BOP deficit → STOP! N at io na l o ut pu t Time High output, low unemployment but high inflation, current account deficit Low inflation, current account surplus but low output, high unemployment π low but Y also low → GO! → π back up again Problems of ‘stop-go’: Conflict of policy goals: BOP and the domestic cycle BUT: Say c/a deficit is persistent – long term downward trend – STOP! or GO! ?? Docsity.com •Late 1960s developing macro instability: Persistent BOT deficit Inflation edging up BOP crisis and devaluation 1967. •Response of Heath government of 1970-4: •‘Free market’ policies •But these backfired. •In particular, intensified the inflationary pressures. Docsity.com • Inflationary pressures, early 1970s: • Sweeping deregulation– ‘Competition and Credit Control’. → Dramatic increase in credit and MS. • 1972-3: ‘Last fling’ of loose monetary and fiscal policy from a Conservative government (‘Barber boom’). • Breakdown of Bretton Woods → ER no longer a restraint on MS. • Strong pressure for W increases. • π already soaring when overtaken by oil price rise late 1973. Docsity.com •Heath government reverted to interventionist counter-measures: –‘Prices and income’ policies. –Seen as unsuccessful. –Conservative government fell 1974. –→ Split in Conservative Party and adoption of Thatcher as Party leader in 1975. •Monetarism -- influential advocates: –In press – writers / editors in Financial Times, Times. –In right wing of Tory Party (Powell, Joseph). –Thatcher became figurehead during late 1970s. Docsity.com
