Monetarism and the US economy: Reply

Abstract

Contrary to the Keynesian view, Monetarists claim that a restrictive fiscal policy without a reduction in the rate of monetary expansion cannot reduce the rate of inflation. Alternatively, Monetarists claim that the impact of a bond financed expansionary fiscal policy is reversed after several quarters. There is also a dispute between the New Classical Economics and (what I define as) the Monetarist position concerning the short-run trade-off between the speed at which inflation is reduced and the temporary rise in the unemployment rate. My 1976 papers concerned with the first point and my recent work (1981, 1982) is concerned primarily with the second point. Meghnad Desai and David Blake have raised proper questions concerning my 1976 attempt to test whether the Monetarist or Keynesian parameter specification, concerning the effects of bond financed fiscal policy, is consistent with the data. Instead of focusing upon reduced form equations as I did, they attempt to derive maximum likelihood estimates of the structural parameters; and they ask whether the underlying structural parameters have Monetarist or Keynesian values. This is the ideal way to proceed. My theoretical system was reduced to a system of three differential equations in the form of eq. (1). The vector of state variables X(t) is: the unemployment rate U(t), the rate of inflation z(t) of the GNP deflator and the anticipated rate of inflation a*(t). Control vector C(t) consists of: the change in real government purchases DC(t), the rate of monetary expansion p(t) and the change in the debt-money ratio DO(t).