ON INFLATION AND THE FEDERAL RESERVE

thelivyjr
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ECONOMIC REVIEW, JANUARY/FEBRUARY 1981

KEYNES ON INFLATION
, continued ...

Thomas M. Humphrey, Federal Reserve Bank of Richmond

Articles in The Times (1937)

The most convincing evidence of his continuing strong opposition to inflation in the 1930s even after the publication of his celebrated General Theory, appears in four articles he wrote for The Times in early 1937.13

There, in discussing policies for dealing with unemployment at the business cycle peak of 1937, he made it abundantly clear that his primary concern was preventing inflation.

In particular, he argued that the 1937 unemployment rate, although very high (“indeed, as high as 12½ percent”), was nevertheless at its minimum noninflationary level at which demand pressure must be curtailed to prevent inflation.

Accordingly, he recommended a sharp cutback in government expenditure on the grounds that the economy was rapidly approaching the point where further increases in aggregate demand would be purely inflationary.

“I believe,” he said, “that we are approaching, or have reached, the point where there is not much advantage in applying a further general stimulus at the centre” [4; pp. 11, 44, 65].

In so stating, he identified the noninflationary full employment rate of unemployment (NIFERU) below which industrial bottlenecks frustrate the intended output and employment effects of aggregate demand expansion policy so that mainly prices rise.14

Beyond that point, he said, noninflationary reductions in joblessness could only be achieved by specific structural policies designed to lower the full employment rate of unemployment itself.

As for the existing high level of that unemployment rate, he attributed it to structural rigidities in the British economy, in particular to a substantial mismatch between the location and skill mix of the labor force and the location and composition of demand.

As he put it, “the economic structure is unfortunately rigid” and this rigidity prevented output and employment from responding to increases in aggregate demand so that only prices rise [4; pp. 11, 65-6].

It follows, he said, that to achieve noninflationary reductions in unemployment “we are more in need today of a rightly distributed demand than of a greater aggregate demand” [4 ; pp. 11, 66].

In other words, noninflationary reductions in unemployment cannot be obtained by expansionary aggregate demand-management policies but rather “require a different technique” [4; pp. 11, 14, 44, 66].

To this end he advocated specific structural policies to reduce unemployment on the grounds that noninflationary reductions in unemployment could only be achieved via measures that eradicate structural rigidities and lower the equilibrium unemployment rate itself.

In so arguing, he foreshadowed by 30 years the modern monetarist concept of the natural rate of unemployment.15

He also refuted the popular contention that he was an inflationist who advocated full employment at any cost.

That is, his 1937 articles amply demonstrate that, far from being an inflationist, his main consideration was preventing inflation - even at a time when the unemployment rate exceeded 12 percent.

The same articles show that, far from advocating full employment at any cost, he clearly thought that there was a fairly high level of unemployment at which expansionary aggregate demand policy should be curbed - to prevent inflation.

From that level downward he insisted that unemployment must be dealt with not by the general expansion of aggregate demand but rather by specific structural policies that reduce the noninflationary unemployment rate itself.

In short, there is nothing in the articles to suggest that Keynes had ever changed his mind about inflation.

On the contrary, he shows the same concern for inflation in his 1937 articles that he earlier displayed in the Tract.

13 These articles are reprinted and discussed in Hutchison [4]. Unless otherwise noted, all references in this section are to Hutchison.

14 The NIFERU concept also appears in the General Theory where Keynes asserts that beyond a certain point, structural impediments (“a series of bottle-necks”) would prevent the noninflationary expansion of output and employment long before full capacity is reached. At the bottleneck point any further increase in aggregate demand would, in his words, largely “spend itself in raising prices, as distinct from employment” [10; pp. 300-l].

15 Hutchison stresses this point, arguing that Keynes “suggested a similar concept to that now called - following Professor Milton Friedman - a ‘natural rate’ of unemployment in that he stressed ‘the unfortunately rigid’ elements in the British economy which made it undesirable to try to reduce unemployment further by the expansion of central government demand” [4; pp. 14-15]. Moreover, “Keynes’s ‘different technique’ . . . corresponded, in some important respects, with what today, following Professor Friedman, is described as reducing the natural rate of unemployment” [4; p. 46]. Similarly, Samuel Brittan writes that “Keynes’s idea of the level of unemployment which would exist without demand deficiency seems astonishingly similar to Milton Friedman’s ‘natural’ rate of unemployment” [4; p. 63, n. 21].

TO BE CONTINUED ...
thelivyjr
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Re: ON INFLATION AND THE FEDERAL RESERVE

Post by thelivyjr »

ECONOMIC REVIEW, JANUARY/FEBRUARY 1981

KEYNES ON INFLATION
, concluded ...

Thomas M. Humphrey, Federal Reserve Bank of Richmond

Concluding Comments

The main conclusion of this essay is that Keynes was neither the subtle inflationist nor the extreme nonmonetarist that he is sometimes depicted as being.

On the contrary, his writings reveal that he consistently deplored inflation, that he warned unceasingly of its dangers, and that he urged that its avoidance be made a primary objective of public policy.


In these respects he shared much with modern monetarists, even to the point of using similar analytical tools.

In that perspective, a key question is how the misconception that he was an inflationist could have arisen.

Whether it stemmed from his General Theory (where he prescribed deficit-spending easy money policies to eliminate excessive unemployment), or from the tendency of some self-styled modern Keynesians to invoke his magic name in behalf of their own inflationary full-employment schemes, or even from his own advocacy of discretion over rules in the conduct of monetary policy, his reputation as an inflationist is highly undeserved.

For, with respect to the General Theory, he did not intend for his expansionist policy prescriptions to apply to inflationary situations.

On the contrary, as documented above, he abandoned these prescriptions in early 1937 upon the first signs of a possible inflation.

Nor would he have had anything but scorn for modern Keynesian policies designed to trade off higher inflation for lower unemployment.

His insistence on the primacy of the goal of absolute price stability would have been in direct conflict with such inflationary policies.

Finally, his support of discretion over rules did not reveal an inflationary bias on his part but rather a belief that discretionary policy was necessary to compensate changes in the demand for money and hence to achieve price level stability.

That is, he differed from the proponents of monetary rules not over the objective of price stability per se, but rather over the means to achieve that objective.

There is nothing in his writings to indicate that he equated proper discretionary policy with the use of price inflation to expand output and employment.

On the contrary, he thought that discretionary policy offered the best means of avoiding inflation and achieving price stability.


In short, given his beliefs about the efficacy of discretionary policy, his advocacy of such policy was perfectly consistent with his antipathy to inflation.

That antipathy amply justifies F. A. Hayek’s judgment that if Keynes were alive today he would be “one of the most determined fighters against inflation” [4; p. 40, n. 1].

References

1. Buchanan, James M., and Wagner, Richard E. Democracy In Deficit: The Political Legacy of Lord Keynes. New York: Academic Press, 1977.

2. Haberler, Gottfried. Inflation, Its Causes and Cures. Revised and enlarged edition. Washington, D. C.: American Enterprise Institute for Public Policy Research, 1966.

3. Howson, Susan. “‘A Dear Money Man’?: Keynes On Monetary Policy, 1920.” Economic Journal (June 1973), pp. 456-64.

4. Hutchison, T. W. Keynes Versus The ‘Keynesians’ . . .? London: The Institute of Economic Affairs, 1977.

5. Keynes, John M. Indian Currency and Finance. 1913. As reprinted in Keynes’ Collected Writings, Vol. I. London: Macmillan, 1971.

6. The Economic Consequences of the Peace. 1919. As reprinted in Keynes’ Collected Writings, Vol. II. London: Macmillan, 1971.

7. A Tract on Monetary Reform. 1923. As reprinted in Keynes’ Collected Writings, Vol. IV. London: Macmillan, 1971.

8. A Treatise on Money, Vol. I: The Pure Theory of Money. 1930. As reprinted in Keynes’ Collected Writings, Vol. V. London: Macmillan, 1971.

9. A Treatise on Money, Vol. II: The Applied Theory of Money. 1930. As reprinted in Keynes’ Collected Writings, Vol. VI. London: Macmillan, 1971.

10. The General Theory of Employment Interest and Money. 1936. As reprinted in Keynes’ Collected Writings, Vol. VII. London : Macmillan, 1973.

11. Patinkin, Don. Keynes’ Monetary Thought: A Study of Its Development. Durham: Duke University Press, 1976.

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