URJC – Doctorado en Economía Aplicada (Tesis doctoral) DYNAMIC MONETARY THEORY AND THE PHILLIPS CURVE WITH A POSITIVE SLOPE ADRIÁN RAVIER Rosario, sábado 7 de agosto de 2010 APPE International Conference, Maui, Hawaii, April 14-16, 2013.

URJC – Doctorado en Economía Aplicada (Tesis doctoral) 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. Rosario, sábado 7 de agosto de 2010 APPE International Conference, Maui, Hawaii, April 14-16, Abstract

Part I: The debate over the Phillips Curve.

URJC – Doctorado en Economía Aplicada (Tesis doctoral) Alban William Housego Phillips ( ) Source: The relation between unemployment and the rate of change of money wage rates in the United Kingdom, A. W. H. Phillips (1958) Rosario, sábado 7 de agosto de 2010 APPE International Conference, Maui, Hawaii, April 14-16, 2013.

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

URJC – Doctorado en Economía Aplicada (Tesis doctoral) The contribution of Paul Samuelson and Robert Solow Rosario, sábado 7 de agosto de 2010 APPE International Conference, Maui, Hawaii, April 14-16, 2013.

URJC – Doctorado en Economía Aplicada (Tesis doctoral) The Keynesian Phillip`s Curve with a negative slope ELEMENTS Short Run oriented approach The stabilizaing effect of monetary policy The Non-Neutrality of Money in the Short-Run Implications for policymakers Rosario, sábado 7 de agosto de 2010 APPE International Conference, Maui, Hawaii, April 14-16, A 0 ULUL U0U0 UHUH Unemployment Rate of Price Change 1 dp P dt

URJC – Doctorado en Economía Aplicada (Tesis doctoral) 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. Rosario, sábado 7 de agosto de 2010 APPE International Conference, Maui, Hawaii, April 14-16, 2013.

URJC – Doctorado en Economía Aplicada (Tesis doctoral) 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 Rosario, sábado 7 de agosto de 2010 APPE International Conference, Maui, Hawaii, April 14-16, B A ULUL UNUN Unemployment Rate of Inflation 1 dp P dt HI G ( 1 dp )** = B P dt ( 1 dp )* = A P dt F ( 1 dp ) = 0 P dt E

Part II: The Bellante-Garrison comparison

URJC – Doctorado en Economía Aplicada (Tesis doctoral) 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) Rosario, sábado 7 de agosto de 2010 APPE International Conference, Maui, Hawaii, April 14-16, 2013.

URJC – Doctorado en Economía Aplicada (Tesis doctoral) The Bellante-Garrison Comparison 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). Rosario, sábado 7 de agosto de 2010 APPE International Conference, Maui, Hawaii, April 14-16, 2013.

Part III: The positive slope of the Phillips curve

URJC – Doctorado en Economía Aplicada (Tesis doctoral) Milton Friedman: A positively sloped Phillips Curve? 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, 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 M is average unemployment during five indicated calendar years. As a result, DP is dated one-half year prior to associated M. Rosario, sábado 7 de agosto de 2010 APPE International Conference, Maui, Hawaii, April 14-16, 2013.

URJC – Doctorado en Economía Aplicada (Tesis doctoral) A positively sloped Phillips Curve? 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 ( , ); in only four out of seven countries between the second and third quinquennia ( and ); and in only one out of seven countries be- tween the final two quinquennia ( and ). Rosario, sábado 7 de agosto de 2010 APPE International Conference, Maui, Hawaii, April 14-16, 2013.

URJC – Doctorado en Economía Aplicada (Tesis doctoral) A positively sloped Phillips Curve? 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. Rosario, sábado 7 de agosto de 2010 APPE International Conference, Maui, Hawaii, April 14-16, 2013.

URJC – Doctorado en Economía Aplicada (Tesis doctoral) A positively sloped Phillips Curve? 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) Rosario, sábado 7 de agosto de 2010 APPE International Conference, Maui, Hawaii, April 14-16, 2013.

URJC – Doctorado en Economía Aplicada (Tesis doctoral) A positively sloped Phillips Curve? 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 Niskanens article and Austrian Business Cycle Theory. Rosario, sábado 7 de agosto de 2010 APPE International Conference, Maui, Hawaii, April 14-16, 2013.

URJC – Doctorado en Economía Aplicada (Tesis doctoral) Labor Market and Natural Unemployment Rosario, sábado 7 de agosto de 2010 APPE International Conference, Maui, Hawaii, April 14-16, W/P W/P* Minimum Wage D S QsQd Natural Unemployment 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.

URJC – Doctorado en Economía Aplicada (Tesis doctoral) Monetary Policy and Less Unemployment in the Short-Term Rosario, sábado 7 de agosto de 2010 APPE International Conference, Maui, Hawaii, April 14-16, W/P W/P* Minimum Wage D S QsQd Less Unemployment Qd D 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.

URJC – Doctorado en Economía Aplicada (Tesis doctoral) Capital Destruction and More Unemployment in the Long-Term Rosario, sábado 7 de agosto de 2010 APPE International Conference, Maui, Hawaii, April 14-16, W/P W/P* Minimum Wage D S QsQd New Natural Unemployment Qd D W/P** 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.

URJC – Doctorado en Economía Aplicada (Tesis doctoral) A Phillips Curve with a Positive Slope: A possible solution to Friedman´s Dilemma Rosario, sábado 7 de agosto de 2010 APPE International Conference, Maui, Hawaii, April 14-16, Frictional Unemploy- ment A B C E D F G U1U1 U2U2 U3U3 U4U Unemploy- ment rate Inflation rate Deflation rate 4 B* Real Wage Rigidity and Structural Unemployment U* Accept the keynesian thesis in the short-run, which we think is compatible with ABCT Partially accept the monetarist theory in the sense that the initial short run effect is reversed in the long run. However, we propose some differences, that can be reduced to three debates: 1.The Non-Neutrality of Money in the Long-Run 2.Subjective Expectations versus adapative and rational expectations 3.The Austrian Business Cycle Theory CAPITAL THEORY

Conclusions

URJC – Doctorado en Economía Aplicada (Tesis doctoral) A Phillips Curve with a Positive Slope: A possible solution to Friedman´s Dilemma Rosario, sábado 7 de agosto de 2010 APPE International Conference, Maui, Hawaii, April 14-16, Frictional Unemploy- ment A B C E D F G U1U1 U2U2 U3U3 U4U Unemploy- ment rate Inflation rate Deflation rate 4 B* Real Wage Rigidity and Structural Unemployment U* Accept the keynesian thesis in the short-run, which we think is compatible with ABCT Partially accept the monetarist theory in the sense that the initial short run effect is reversed in the long run. However, we propose some differences, that can be reduced to three debates: 1.The Non-Neutrality of Money in the Long-Run 2.Subjective Expectations versus adapative and rational expectations 3.The Austrian Business Cycle Theory ??? CAPITAL THEORY

URJC – Doctorado en Economía Aplicada (Tesis doctoral) Rosario, sábado 7 de agosto de 2010 APPE International Conference, Maui, Hawaii, April 14-16, Frictional Unemploy - ment A B C E D F G U1U1 U2U2 U3U3 U4U Unemploy- ment rate Inflation rate Deflation rate 4 B* Real Wage Rigidity and Structural Unemployment U* B A ULUL UNUN Unemploymen t Rate of Inflation 1 dp P dt HI G ( 1 dp )** = B P dt ( 1 dp )* = A P dt F ( 1 dp ) = 0 P dt E A 0 ULUL U0U0 UHUH Unemployment Rate of Price Change 1 dp P dt Thank you!