chapter 13-2 institutionalists take on the monetarist
TRANSCRIPT
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Chapter 13-2
Institutionalists take on the Monetarist
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Institutionalist Theories of Inflation
• Supporters of institutional theories of inflation accept much of the quantity theory.
• While they agree that money and inflation move together, they have different causes and effects.
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Institutionalist Theories of Inflation
• According to the quantity theory, the direction of causation moves from left to right:
MV PQ
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Institutionalist Theories of Inflation
• Institutional theories see it the other way round.
• Increases in prices forces government into positions where it must increase money supply or cause unemployment.MV PQ
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Institutionalist Theories of Inflation
• According to the quantity theory, changes in money cause changes in prices.
PQMV
• According to the institutionalists, increases in prices force the government to increase the money supply.
PQMV
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Institutionalist Theories of Inflation
• According to these theorists, the source of inflation is in the price-setting process of firms.
• Firms find it easier to raise prices than to lower them.
• Firms do not take into account the effect of their pricing decisions on the overall price level.
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Focus on the Price-Setting Decisions of Firms
• Any increase in firms’ wages, rents, taxes, and other costs are simply passed on to consumers in the form of higher prices.
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Focus on the Price-Setting Decisions of Firms
• This works so long as the government increases the money supply so that demand is there to buy the goods at the higher prices.
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Focus on the Price-Setting Decisions of Firms
• Whether the firm selects this price-raising strategy depends on the state of the labor market.
• If the labor market is tight, the firm knows that it will lose workers if it doesn’t raise wages.
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Changes in the Money Supply Follow Price-
Setting by Firms• Institutional theorists see the
nominal wage- and price-setting process as generating inflation.
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Changes in the Money Supply Follow Price-
Setting by Firms• One group pushes up its nominal
wage and/or price, other groups responds by doing the same.
• The first group finds its relative wages and/or prices have not increased, so they raise them again.
• And the process begins anew.
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Changes in the Money Supply Follow Price-
Setting by Firms• At this point, government has two
options:
• Increase money supply, thereby ratifying the inflation.
• Refuse to ratify the inflation, thereby causing unemployment to rise.
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The Insider/Outsider Model and Inflation
• The insider-outsider model is an institutionalist story of inflation where insiders bid up wages and outsiders are unemployed.
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The Insider/Outsider Model and Inflation
• Insiders are business owners and workers with good jobs with excellent long-run prospects; outsiders are everyone else.
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The Insider/Outsider Model and Inflation
• If markets were purely competitive, wages, profits, and rents would be pushed down to equilibrium levels.
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The Insider/Outsider Model and Inflation
• Insiders don’t like this, so they develop sociological and institutional barriers to prevent competition from outsiders.• Barriers include unions, laws restricting the
firing of workers, and brand recognition.
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The Insider/Outsider Model and Inflation
• Outsiders must take dead-end, low-paying jobs or try to undertake marginal businesses that pay little return per hour worked.
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The Insider/Outsider Model and Inflation
• Outsiders are the first to be fired and their businesses are the first to fail in a recession.
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The Insider/Outsider Model and Inflation
• The economy is only partially competitive – the invisible hand is thwarted by social and political forces.• Insiders push to raise their nominal
wages to protect their real wages while outsiders suffer.
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Policy Implications of Institutionalist Theories
• The quantity theorists have a simple solution for stopping inflation – just cut the growth of the money supply.
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Policy Implications of Institutionalist Theories
• The institutional theorists agree with this prescription, but they argue that is not only inefficient but unfair.• It causes unemployment among
those least able to handle it.
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Policy Implications of Institutionalist Theories
• They favor contractionary monetary policies used in combination with incomes policy to directly slow down inflation.
• Incomes policy – places direct pressure on individuals and businesses to hold down their nominal wages and prices.
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Policy Implications of Institutionalist Theories
• Formal incomes policies have been out of favor for a number of years.
• Informal incomes policies exist in many European nations.