The New Consensus on Monetary Policy and its Post-Keynesian Critique

Abstract

This paper seeks to look at the underlying framework of the New Consensus models, providing a Post-Keynesian critique. In the light of this critique, the model is reformulated, with its basic structure intact, but with alternative post-Keynesian specifications of the Phillips curve being considered. It is shown that such modifications, either allow a long run trade-off between the rate of inflation and the level of output, the rate of capacity utilization and, therefore, unemployment, or, in our preferred specification, changes in output and capacity have no implications for inflation over a large range of capacity utilization.

Acknowledgments

The first version of this paper was written during the Summer of 2004, when Peter Kriesler visited the Robinson Center in Ottawa. That version was presented at the third Australian Society of Heterodox Economists conference, which was held at the University of New South Wales, in Sydney, in December 2004. The authors wish to thank the participants to this conference, as well as Mario Seccareccia and Jung Hoon Kim, for their helpful comments. Marc Lavoie wishes to thank the Center for Full Employment and Price Stability (C-FEPS) at the University of Missouri in Kansas City, for its financial support at the time the paper was written.

Notes

¹Indeed, officials at the Bank of Canada have explained to one of us that the central bank need not know the ‘natural’ rate of interest. If the inflation rate settles at a rate higher than the target rate, the central bank only has to raise the real rate until the target inflation rate is achieved, a behaviour which corresponds to equation (3c).

²The importance of this second term for stability analysis is confirmed by the numerical analysis of Alonso-González & Palacio-Vera (2002).

³Indeed, some neoclassical authors reject the NAIRU. Solow (1990) for instance claims that calculating the NAIRU as being the simple average of the actual rates of unemployment over the previous five years does a better job than calculating a NAIRU based on standard supply-side factors. Any rate of unemployment held for a sufficiently long length of time will generate stable inflation after a period of accelerating or decelerating inflation.

⁴It should be pointed out that the famous Solow neoclassical growth model is of little use in analysing the dynamics of the problem at hand, since the model starts out by assuming full labour employment and full capacity output. By definition, unemployment cannot arise in that model.

⁵As shown by Setterfield et al. (1992), by modifying the definitions of various supply-side variables, and by adopting one or another mechanism to define expected inflation, there are nearly infinite possibilities in arriving at a conveniently measured NAIRU allowing the central bank to claim that the current rate of unemployment is close to equilibrium.

⁶A further reason for a hysteretic rate of unemployment may arise if the central bank also adjusts its view of what it considers to be the normal rate of utilization of capacity. This is linked to our fourth critique of the New Consensus, as described in the previous section. Multiple equilibria may also arise when normal rates of capacity utilization are endogenous and move with actual rates, as shown by Lavoie (1996) and Dutt (1997).

⁷We discovered this after labouring to describe this alternative Post-Keynesian Phillips curve. The student of one of us, Peng Wang, has preliminary results that confirm Filardo's view. Based on US data of 1970–2003, Wang finds that the Phillips curve is flat for rates of capacity of utilization that stand between 77 and 83%.