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Monetary Accommodation of Supply Shocks under Rational Expectations

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  • Alan S. Blinder

Abstract

In dealing with the expectationists' arguments, I will divide them (somewhat artificially) into two groups. Arguments in the first group, which I call "present disaster" arguments, allege that econometric models err by understating the reaction of inflationary expectations. For example, it is claimed that a policy of monetary accommodation would increase inflationary expectations, shift the short-run Phillips curve upward, and defeat the purpose of the expansionary policy. Arguments in the second group, which I call "future disaster" arguments, are more subtle, but also more elusive. The idea is that by informing private agents that it will accommodate supply shocks in the future, the monetary authority would exacerbate the downward rigidity of wages and prices, thus making it more difficult to deal with future supply shocks. Such arguments are cases of the Lucas [12] econometric policy critique, since they suggest that policy changes will cause parameter shifts. Neither of these arguments is implausible on its face. The problem is that it is hard to know how to evaluate them until they are formalized in theoretical models and then tested empirically. This paper takes one small step in that direction by augmenting two popular macro models with rational expectations so that they are capable of dealing with supply shocks, and then examining both the present and future disaster arguments in the context of each.

Suggested Citation

  • Alan S. Blinder, 1980. "Monetary Accommodation of Supply Shocks under Rational Expectations," NBER Working Papers 0464, National Bureau of Economic Research, Inc.
  • Handle: RePEc:nbr:nberwo:0464
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    1. Aizenman, Joshua & Frenkel, Jacob A, 1986. "Supply Shocks, Wage Indexation and Monetary Accommodation," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 18(3), pages 304-322, August.
    2. Froyen, Richard T & Waud, Roger N, 1988. "Real Business Cycles and the Lucas Paradigm," Economic Inquiry, Western Economic Association International, vol. 26(2), pages 183-201, April.
    3. Matthew B. Canzoneri & Jo Anna Gray, 1983. "Two essays on monetary policy in an interdependent world," International Finance Discussion Papers 219, Board of Governors of the Federal Reserve System (U.S.).
    4. Alan S. Blinder & Jeremy B. Rudd, 2012. "The Supply-Shock Explanation of the Great Stagflation Revisited," NBER Chapters,in: The Great Inflation: The Rebirth of Modern Central Banking, pages 119-175 National Bureau of Economic Research, Inc.
    5. Alan S. Blinder & Ricardo Reis, 2005. "Understanding the Greenspan standard," Proceedings - Economic Policy Symposium - Jackson Hole, Federal Reserve Bank of Kansas City, issue Aug, pages 11-96.
    6. Turnovsky, Stephen J, 1987. "Supply Shocks and Optimal Monetary Policy," Oxford Economic Papers, Oxford University Press, vol. 39(1), pages 20-37, March.
    7. John B. Taylor, 1982. "The role of expectations in the choice of monetary policy," Proceedings - Economic Policy Symposium - Jackson Hole, Federal Reserve Bank of Kansas City, pages 47-95.
    8. Robert J. Gordon, 2011. "The History of the Phillips Curve: Consensus and Bifurcation," Economica, London School of Economics and Political Science, vol. 78(309), pages 10-50, January.
    9. Robert Rennhack, 1991. "La Conducción de la Política Monetaria," Latin American Journal of Economics-formerly Cuadernos de Economía, Instituto de Economía. Pontificia Universidad Católica de Chile., vol. 28(83), pages 11-20.
    10. repec:pri:cepsud:176blinder is not listed on IDEAS
    11. Froyen, Richard T & Waud, Roger N, 1987. "An Examination of Aggregate Price Uncertainty in Four Countries and Some Implications for Real Output," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 28(2), pages 353-372, June.
    12. repec:pri:cepsud:114blinderreis is not listed on IDEAS
    13. Gerard Caprio, 1982. "The Swedish economy in the 1970's: the lessons of accommodative policies," International Finance Discussion Papers 205, Board of Governors of the Federal Reserve System (U.S.).

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