Monday, July 29, 2019

Origin of the 2 Percent Inflation Target — J. Barkley Rosser

So it was 1990 that the New Zealand central bank became the first in the world to impose an inflation target of 0-0.002....
Origin of the 2 Percent Inflation Target
J. Barkley Rosser | Professor of Economics and Business Administration James Madison University

1 comment:

AXEC / E.K-H said...

Right policy depends on true theory
Comment on Barkley Rosser on ‘Origin of the 2 Percent Inflation Target’

Barkley Rosser reports: “In the mid-90s the US grew better than it had previously, and in the middle of the decade there was an important moment regarding policy. There was no inflation directive but Fed Chair Greenspan was facing a de facto such directive based on central Fed estimates that there was a known ‘natural rate of unemployment (= NAIRU)’ that must not be passed. As it was then Fed Gov Janet Yellen in the mid 90s convinced Greenspan not to raise interest rates partly because of a paper by her husband, Noblelist George Akerlof.”

The NAIRU Phillips Curve is the centerpiece of standard employment theory. Economists get employment theory wrong for 200+ years now. This has dire consequences for economic policy and ultimately for WeThePeople.

“In order to tell the politicians and practitioners something about causes and best means, the economist needs the true theory or else he has not much more to offer than educated common sense or his personal opinion.” (Stigum)

Economists do not have the true theory. By consequence, economic policy guidance has NO sound scientific foundations. This holds from Adam Smith onward to the policy of the Federal Reserve.

The NAIRU Phillips Curve has always been proto-scientific garbage.#1 The correct (macrofounded, systemic, behavior-free, testable) employment theory boils down to the structural-systemic Phillips Curve which is shown on Wikimedia.#2

The equation says that unemployment u is the dependent variable and the expenditure ratio rhoE=C/Y, the factor cost ratio rhoF=W/PR, investment expenditures I, productivities R and prices P in the consumption and investment goods industries are the independent variables. The variables rhoE and I are, in turn, influenced by interest rates. Translated into policy, the equation says that in order to control employment the independent variables have to be controlled.

From the macroeconomic Employment Law follows:

(i) An increase in the expenditure ratio rhoE leads to higher employment L.

(ii) Increasing investment expenditures I exert a positive influence on employment.

(iii) An increase in the factor cost ratio rhoF=W/PR leads to higher employment.

The complete employment equation contains in addition profit distribution, the public sector, and foreign trade.

Item (i) and (ii) cover the familiar arguments about aggregate demand. The factor cost ratio rhoF as defined in (iii) embodies the macroeconomic price mechanism. The fact of the matter is that overall employment INCREASES if the average wage rate W INCREASES relative to average price P and productivity R. Or, the other way round, overall employment DECREASES if the average price P INCREASES relative to average wage rate W with productivity R unchanged. Roughly speaking, price inflation is bad for employment and wage inflation is good.

This is the exact opposite of what standard economics says: “We economists have all learned, and many of us teach, that the remedy for excess supply in any market is a reduction in price. If this is prevented by combinations in restraint of trade or by government regulations, then those impediments to competition should be removed. Applied to economy-wide unemployment, this doctrine places the blame on trade unions and governments, not on any failure of competitive markets.” (Tobin)

The testable Employment Law tells one that the best policy to stabilize employment on a high level is a price inflation of zero and a wage inflation equal to productivity increases. The 2 percent inflation target has always been political idiocy.

Egmont Kakarot-Handtke

#1 For details of the big picture see cross-references Employment/Phillips Curve

#2 Wikimedia AXEC62 Structural-systemic Phillips Curve