Monetarism Notes

Econ 102Mr. 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– Tanaka started in the construction industry, used tha

t to raise campaign funds for faction / political party

• 1971 ¥/$ appreciation: end of “Bretton Woods”– huge inflow of dollars, bought to lessen forex shift bu

t boosted money supply / lowered interest rates

• Sum: both stimulative MP and stimulative FP– Double-digit inflation by 1973

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

Bank of Japan reaction

April 1973 4.5% --> 5%

May 1973 5.5%

July 1973 6%

August 1973 7%

December 1973 9%

April 1975 Began lowering

Money Supply

0

100,000

200,000

300,000

400,000

500,000

600,000

1969.011969.071970.011970.071971.011971.071972.011972.071973.011973.071974.011974.071975.011975.071976.011976.071977.01

0.0%

5.0%

10.0%

15.0%

20.0%

25.0%

30.0%

35.0%

M1 Currency Deposits M1 Growth

Money Supply

-20.0%

0.0%

20.0%

40.0%

60.0%

80.0%

100.0%

120.0%

140.0%

1970.011970.041970.071970.101971.011971.041971.071971.101972.011972.041972.071972.101973.011973.041973.071973.101974.011974.041974.071974.101975.011975.041975.071975.10

-5.0%

0.0%

5.0%

10.0%

15.0%

20.0%

25.0%

30.0%

35.0%

40.0%

45.0%

Wholesale Prices, Monthly Rate (Annualized) M1 Growth Wholesale Prices vs Previous Year

Analytic issues

• Time lags– Recognition

– Implementation

– Impact

• Time consistency– Short-run versus long-run

• Structural issues– Institutional change renders historical relationships

(model parameters) misleading

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?

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

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

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

Other aspects

• FP side effects– Implications of lifetime consumption model

• MP side effects– Do you really want low investment to persis

t?– Are big swings in forex rates desirable?

• International side effects– How to respond to exogenous forex shifts?

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