ECON 309 Orthodox Monetarism 18 Orthodox Monetarism 2 Integration of global

Econ 309 orthodox monetarism 18 orthodox monetarism 2

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ECON 309 Orthodox Monetarism 18
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Orthodox Monetarism 2. Integration of global financial markets changed the relationship between M3 and the demand for goods and services. Money supply became a weaker indicator of underlying inflation. The SARB abandoned money supply targeting in favour of eclectic approach. Package of indicators used as guideline for MP: Movements in M1,M2,M3 Bank credit extension Yield curve and interest rates Current and capital account movements Movements in the exchange rate ECON 309 Orthodox Monetarism 19
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Why money supply targeting was abandoned? Inaccurate application- not inline with Orthordox Monetarism Money supply not entirely exogenous- eg. Money demand may be interest insensitive. Velocity of circulation unstable. Integration of global financial markets Extension of banking services to the previously unbanked ECON 309 Orthodox Monetarism 20
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ECON 309 Orthodox Monetarism 21
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ECON 309 Orthodox Monetarism 22
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The expectations-augmented Phillips curve Monetary policy cannot be used to solve structural problems such as the unacceptably high level of unemployment … structural problems call for structural solutions, in this case measures targeted at making labour and product markets work more flexibly” – Dussienberg, 1999 What influenced the view that MP cannot be used to influence real variables in the economy? In the long-run an increase in money supply will have no impact on real variables Only in the short-run can real effects be achieved-short lived ECON 309 Orthodox Monetarism 23
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The expectations-augmented Phillips curve Keynesian belief in the use of monetary and fiscal policies to reduce unemployment not shared by monetarists. An increase in money supply is spread between a rise in price and a rise in output. A.W. Philips conducted a study of British data, wages and unemployment. Plot of inflation and unemplymnt in USA 1961-1969 fit the data very well No smooth relationship in 1970’s through to 1990’s Keynesians recognised the trade-off between inflation and unemployment- Phillips curve. Inflation becomes the necessary cost of achieving the social goal of minimal unemployment. ECON 309 Orthodox Monetarism 24
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The expectations-augmented Phillips curve Friedman and Phelps denied the existence of a permanent trade-off between inflation and unemployment. In the long-run an increase in money supply will have no influence on unemployment- only influence is on nominal variables In the short-run an increase in money supply may influence both real and nominal variables. Problem : the rate of change of money wages is determined independently of the rate of inflation. ( Money illusion ) Late 1960’s/ early 1970’s standard Phillips curve was challenged by stagflation The existence of high inflation and high unemployment. ECON 309 Orthodox Monetarism 25
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The expectations-augmented Phillips curve Employers and employees are interested in real, not money wages What affects the anticipated real wage is the rate of inflation expected to exist throughout the period of the contract.
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