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Price Inertia and Policy Ineffectiveness in the United States, 1890-1980

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Robert J. Gordon

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Abstract

This paper introduces a new approach to the empirical testing of the Lucas- Sargent-Wallace (LSW) "policy ineffectiveness proposition." Instead of testing that hypothesis in isolation from any plausible alternative, the paper develops a single empirical equation explaining price change that includes as special cases both the LSW proposition and an alternative hypothesis. The alternative, dubbed "NRH-GAP," states that prices respond fully in the long run, but only gradually in the short run, to nominal aggregate demand disturbances. A second innovation is the development of a quarterly data file for the period 1890-1980, thus opening up more than 200 new quarterly observations for analysis. A third innovation is the testing of three different methods of introducing "persistence effects" into the LSW analytical framework. In conflict with the predictions of the LSW approach, the results here exhibit uniformly high coefficients of real output and low coefficients of price changes in response to anticipated nominal GNP changes. Further, price changes respond positively and output responds negatively to lagged changes in prices, reflecting the short-run inertia in price-setting that forms the basis for the alter- native NRH-GAP approach. Evidence is also provided that velocity tends to respond negatively to anticipated changes in money, in contrast to the usual assumption in this literature of random serially independent velocity changes. Two shifts in the structure of the price-setting process are noted--a much higher degree of price responsiveness during World War I and its aftermath, and a longer mean lag in the influence of past price changes after 1953. Of independent interest, beyond its treatment of the policy ineffectiveness debate, is the treatment in the paper of changes in monetary regimes, and of the impact of programs of government intervention. The money creation process exhibits a highly significant change in structure before and after World War I, and a marginally significant change in 1967. The results identify five episodes of government intervention that significantly displaced the time path of prices -- the National Recovery Act of 1933-35, and price controls during the two world wars, Korea, and the Nixon era.

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Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 0744.

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Date of creation: Feb 1983
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Handle: RePEc:nbr:nberwo:0744

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  1. Chow, Gregory C & Lin, An-loh, 1971. "Best Linear Unbiased Interpolation, Distribution, and Extrapolation of Time Series by Related Series," The Review of Economics and Statistics, MIT Press, vol. 53(4), pages 372-75, November. [Downloadable!] (restricted)
  2. Bull, Clive & Frydman, Roman, 1980. "On the Interpretation of the Lucas Supply Function in Rational Expectations Models," Working Papers 80-24, C.V. Starr Center for Applied Economics, New York University. [Downloadable!]
  3. Jon Frye & Robert J. Gordon, 1981. "Government Intervention in the Inflation Process: The Econometrics of "Self-Inflicted Wounds"," NBER Working Papers 0550, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
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  4. Small, David H, 1979. "Unanticipated Money Growth and Unemployment in the United States: Comment," American Economic Review, American Economic Association, vol. 69(5), pages 996-1003, December. [Downloadable!] (restricted)
  5. Barro, Robert J, 1977. "Unanticipated Money Growth and Unemployment in the United States," American Economic Review, American Economic Association, vol. 67(2), pages 101-15, March.
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  6. Flood, Robert P. & Garber, Peter M., 1980. "A pitfall in estimation of models with rational expectations," Journal of Monetary Economics, Elsevier, vol. 6(3), pages 433-435, July. [Downloadable!] (restricted)
  7. Tobin, James, 1980. "Are New Classical Models Plausible Enough to Guide Policy?," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 12(4), pages 788-99, November. [Downloadable!] (restricted)
  8. Christopher A. Sims, 1980. "Comparison of Interwar and Postwar Business Cycles: Monetarism Reconsidered," NBER Working Papers 0430, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
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  9. McCallum, Bennett T, 1977. "Price-Level Stickiness and the Feasibility of Monetary Stabilization Policy with Rational Expectations," Journal of Political Economy, University of Chicago Press, vol. 85(3), pages 627-34, June. [Downloadable!] (restricted)
  10. Robert J. Gordon & James A. Wilcox, 1981. "Monetarist Interpretations of the Great Depression: An Evaluation and Critique," NBER Working Papers 0300, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
  11. Blinder, Alan S. & Fischer, Stanley, 1981. "Inventories, rational expectations, and the business cycle," Journal of Monetary Economics, Elsevier, vol. 8(3), pages 277-304. [Downloadable!] (restricted)
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  1. Marika Karanassou & Hector Sala & Dennis Snower, 2008. "Phillips Curves and Unemployment Dynamics: A Critique and a Holistic Perspective," Kiel Working Papers 1441, Kiel Institute for the World Economy. [Downloadable!]
    Other versions:
  2. repec:fip:fedreq:y:1982:i:nov:p:3-12:n:v.68no.6 is not listed on IDEAS
  3. repec:fip:fedreq:y:1990:i:jul:p:31-39:n:v.76no.4 is not listed on IDEAS
  4. K. Alec Chrystal & David Peel, 1984. "Money and activity in the U.K. 1961-1983: surprise? surprise!," Working Papers 1984-011, Federal Reserve Bank of St. Louis. [Downloadable!]
  5. Clemens J.M. Kool & R.W. Hafer, 1988. "Stock prices, inflation and real activity: a test of the Fama hypothesis, 1920-84," Working Papers 1986-001, Federal Reserve Bank of St. Louis. [Downloadable!]
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