MONETARY POLICY AND INTERNATIONAL COMPETITIVENESS: THE PROBLEMS OF ADJUSTMENTA story of smart speculators and sticky prices, set in a world of high-speed capital movements

TL;DR: In this paper, the authors show that the rate of inflation responds ceteris paribus one-for-one to changes in the growth rate of the nominal money stock and its rate of change is endogenous to the model via an augmented Phillips curve.

Abstract: MOST advocates of controlling the money supply as a cure for inflation are willing to concede that there is a lag between changes in the money supply and their effects on the price level. Thus, in evidence to the Treasury and Civil Service Committee (1980, p. 59) Milton Friedman put this lag at roughly two years "for the U.S., U.K. and Japan". Some recent contributions of authors belonging to the "New Classical Macroeconomics" school' deny the existence of such a lag for fully perceived or anticipated changes in the money supply. In the U.K. this position has been adopted by Patrick Minford (Minford (1980)). We reject the efficient markets hypothesis that generates this short-run monetary neutrality proposition as a valid characterization of the operation of labour and product markets in an economy like the U.K. Instead we postulate inertia (sluggishness or stickiness) of the domestic price level or, in a variant of our basic model, of both the price level and its rate of change.2 While the domestic price level is therefore always treated as predetermined, its rate of change is endogenous to the model via an augmented Phillips curve. To capture what appears to us to be the spirit of optimistic monetarist analysis, we assume in most of what follows that the rate of inflation responds ceteris paribus one-for-one to changes in the rate of growth of the nominal money stock. The case in which there is more inertia in the underlying or "core" rate of inflation is also considered. Throughout our analysis we assume that the inflation equation, and the degree of nominal inertia it incorporates, is invariant under the policy changes and the other parameter changes that we consider. Endogenous changes in the degree of price stickiness in response to perceived changes in monetary policy etc., (say because of induced changes in contracting behaviour in labour and product markets) may qualify our results. They will