The economics of inflation and output fluctuations in the NETHERLANDS, 1954–1975 A test of some implications of the dominant impulse-cum-rational expectations hypothesis

Abstract

The purpose of this paper is to give an economic explanation of the proportionate rates of change of the a-qregatc levels of prices and private domestic output in the Netherlands over the postwar period 1954-75. Basic to this explanation is the contention that agyregatc fluctuations in prices and output arc dominated by systematic impulses operating on the economy. Four classes of such systematic impulses are distinguished: fiscal, foreign, monetary, and financial. The policies pursued by the government with respect to expenditures and tax rates impose a fiscal impulse on the economy. Changing claims of the foreign sector on domestic private output and changes in prices (and exchange rates) to be paid for domestic claims on foreign output impose foreign impulses on the economy. Finally, changes in the stocks of money and government debt brought about by monetary policy, government deficit financing, and managing the exchange rate impose monetary and financial impulses on the economy. All these impulses have in common that they impose or release contending claims on private domestic output that have to be resolved by changes in prices and/or output. The transmission of these fiscal. foreign, monetary, and financial impulses to prices and output is governed by a relative-price stock-flow mechanism as set forth in Brunner (1976) and Brunner and Meltzer (1976a, 1976b3. Five markets are involved in this mechanism: the markets for output, money, private and governrnent debt (credit), physical capital, and labor. Five economic agents operate in these markets: the government and the central bank, the banking system. the public and the foreign sector. The private nongovernment sector is assumed to behave rationally and to form its expectations about economic variables consistent with economic theory. In other words,