Stephen Colbert is right; reality does have a liberal
bias. Or at least that is what the new study
by D’Agostino & Surico posted at voxeu.org seems to suggest. They forecast inflation using a Vector
Auto-Regression (VAR) model. They test
for the relation between inflation and money, inflation and output, and
inflation and past inflation in the United States from 1904 to 2004. Their results show that:
“Under the gold standard, the
Bretton Woods system and most of the great moderation sample [in other words,
almost the whole sample] money growth and output growth had no marginal
predictive power for inflation;”
And “output growth had marginal
predictive power for inflation in only two periods: (i) the years that extend
from the great inflation of the 1970s to the early 1980s … and (ii) the years
between 1997 and 2000.”
In other words, money supply is never significant, output
very seldom, and the only thing that really matters is past inflation. So much for monetarist views according to
which money supply explains economic history!
In the face of this paper, the only puzzling question is why the
Monetarist view of history, as expressed in Friedman & Schwartz, and more
recently in Meltzer, is still so popular.
There explicit conclusion is that: “the results reported in
this column are consistent with the idea that a policy regime which successfully
stabilizes inflation makes it harder to improve upon the forecasts based on
“naive” models.” English translation:
the conventional idea that too much demand triggered by monetary expansion
causes inflation does not work when compared to the simple idea of inflationary
inertia. Inflation is high if it was
high in the past.
The first period in which output growth has predictive power
is, incidentally, a period in which commodity prices boomed, and that means
that inflation might be orthogonal to output growth, even if both are
correlated. The second period was
associated to both a stock market and a housing bubble, and asset price
inflation may also not result from full employment (output increasing beyond
its potential).
They should have explicitly noted that periods (monetary
regimes) with low inflation could not be explained simply by lack of excess
demand or monetary expansionism, since those are ruled out by their own
econometric work. I wonder what explains
monetary regimes that produce price stability? Interestingly enough the authors do not seem
to have an interest in what causes past inflation or price stability!
PS: Thanks to Steve Bannister for directing me to their
post. He may have something to say later
on the advantages and the limitations of the econometric techniques used by the
authors. Also, he is giving a talk on
heterodox approaches to econometrics this coming Friday. Will post a link to his talk later.
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