Hello to all,
If you can tell from the title of this thread I have just finished Frank Hahn's Inflation and Money. A main premise of his book is that an increased quantity of money isn't necessarily a condition for inflation. I have trouble following his terminology, so I am interested if anybody can explain here what he's saying and if his theory is accurate or false. The following is from pages 82-84, which I think best sums up his ideological thinking:
“Take the simplest example I can think of: The Solow 1956 growth model. Let us start the story with an initial capital-labor ratio below its steady-state value. We now append to this a Lucasian supply curve of labor derived on a perfect foresight assumption. In particular, workers correctly foresee their rising real wages on the path- it may take a very long time- to steady state. Similarly, the household savings decisions are derived from inter temporal perfect foresight optimization. The model is now different from Solow's, but one can find a path that seeks the steady state and along with the real wage is rising. The natural level of employment will be increasing.
Now suppose the money stock is constant. For what follows, all my arguments would also hold if the money stock is increasing at the rate given by steady-state growth, which would be less than the growth experienced during the adjustment phase. Then, on the usual and especially the Monetarist assumptions, the price level must be falling to provide the extra real cash balances required for higher output. On the simplest Monetarist view, it must be falling at the rate at which output is increasing in excess of its steady-state rate. But that is made up of an increase in the marginal product of labor (as the capital:labor ratio rises) and an increase in work as the real wage rises. Hence the rate of price fall must be greater than the rate of increase in the marginal product of labor, and so money wages will have to be falling all along this path. I have already at length discussed why, when one thinks of the mechanics of wage formation, and in particular notes relative wage deprivation, this path may in fact not be feasible. But I admit that one can tell a story of a very abstract kind where this obstacle would not arise.
But there is now another obvious point. The rate of price deflation makes money holding more attractive relative to physical capital. So the actual sequence of natural employment levels is bound to be affected. This is really the Tobin point in a non-steady state context. But let us make it really dramatic by the following modification: assume that infinitely long-lived capital, once bolted down, cannot be sold. We are starting with a given bolted-down stock and given employment which makes the capital-labor ratio less than its steady-state value. I now want the price and wage level to fall at a rate slightly higher than the marginal product of capital. Of course I want rational expectations. Then there will be a sequence of money stocks such that (a) all savings are in the form of money only, and (b) desired savings (additions to assets) are just equal to the increase in the real money stock. If we abstract from population growth and technical progress the asymptotic state in zero savings, a constant real money stock and a declining nominal stock and price level, it is a rational expectations equilibrium, and everyone fully foresees the money stocks. But the economy never gets to the Solowian steady state. The natural unemployment level certainly here is not invariant to the deflation rate.
But, of course, it is not invariant to the inflation rate, either. By monetary policy, fully foreseen, we can speed up the path to the steady state. I have discussed this before and do not now pursue it. I hope to have shown how much the 'vertical; Philips curve relies on steady-state assumptions. I am pretty sure that this point must have been made in the literature before, and that it is known to many economists. What is puzzling is that we keep on hearing so much about there being no trade-off. Is it being supposed that the UK, for instance, is in a steady-state equilibrium? Recall also that nowhere in this account have I appealed to an assumption that leads workers not to know their real wage.
Rational expectations economists are, it seems to me, in some difficulty here. One must surely allow governments to be endowed with the facility for rational expectations formation, which is so liberally assigned to the individual agents. Explanations of 'undue' monetary expansion must then turn on elections and seigneurage. But workers can only be electorally fooled if they do not observe the money stock, the behavior of which is being broadcast daily to the country. Of course, if we allow workers to be temporarily fooled, even if they observed the monetary aggregates, this objection falls away. But then we abandon the rational expectations hypothesis. We can then, however, deduce the behavior of the money stock from that of the labor market: inflation is generated by the propensity of workers to be fooled and by the advantage to a rational government to fool them. If workers cannot be fooled, then there is no advantage to governments from inflation. That leaves seigneurage. It too depends on the lack of understanding by private agents that the inflation imposes a tax on them. It would be hard to establish that they rationally prefer this form of taxation to more direct methods.
It seems to me, therefore, strongly arguable that the behavior of the money stock depends on that of the labor market. If there is merit in the arguments for a natural rate of inflation, then this would also explain why the monetary stock behavior allows inflation. For there are clear advantages to a government to allow the inflation rate that is required by the unfolding of the natural employment level over states and time.”
Warm Regards,
Matt
This claim is interesting, though I will not pretend to be fully qualified to assess it:
The rate of price deflation makes money holding more attractive relative to physical capital.
I've seen this type of argument before, usually from people with a less academic background. I think what he's saying here however rests on the idea common to the neoclassical literature that marginal productivity of capital determines the "return" on capital which with presumably a rising purchasing power would look less attractive compared to hoarding money. If on the other hand we understand productivity to be irrelevant to the explanation of interest, and instead as a non-universally arbitraged (outside of the ERE) discount on future money, then I think it would be reasonable to rather expect just a rise in negotiated discounts or interest rates with regard to long term bonds and capital investments, and therefore also a drop in DMVP. It makes sense in another way to see a rise in interest rates considering money as a "present good" here too.
If to use modern understanding this fall in purchasing power was "rationally expected" then there would be no issue. I'll let others decide if they feel I'm possibly talking out of my backend here.
"When the King is far the people are happy." Chinese proverb
For Alexander Zinoviev and the free market there is a shared delight:
"Where there are problems there is life."