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The Art of Paradigm Maintenance: How the 'Science of Monetary Policy' tries to deal with the inflation of 2021-2023

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  • Servaas Storm

    (Delft University of Technology)

Abstract

The macroeconomic models used by major institutions including the Federal Reserve and the International Monetary Fund (IMF) failed to predict the inflation surge during 2021-2023. The output gap, the unemployment gap, the New Keynesian Phillips curve and inflation expectations did not give timely and relevant signals. The re-emergence of inflation thus threw the 'science of monetary policy' off the rails. Faced with the choice between changing their paradigm and proving that there is no need to do so, the 'scientists of monetary policy' got busy on the proof. As a result, a number of ad-hoc epicycles have been added to the New Keynesian analytical core, with the help of which one can claim to be able to explain the sudden acceleration of inflation post-factum. This paper critically reviews the theoretical and empirical merits of three recent tweaks to the New Keynesian core: using the vacancy ratio as the appropriate measure of real economic activity; hammering on the considerable risk of an imminent wage-price spiral; and the resurrection of the non-linear Phillips curve. The paper concludes by drawing out sobering lessons concerning the art of paradigm maintenance as practiced by the 'scientists of monetary policy'.

Suggested Citation

  • Servaas Storm, 2023. "The Art of Paradigm Maintenance: How the 'Science of Monetary Policy' tries to deal with the inflation of 2021-2023," Working Papers Series inetwp214, Institute for New Economic Thinking.
    • Handle: RePEc:thk:wpaper:inetwp214
    DOI: 10.36687/inetwp214
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    File URL: https://ssrn.com/abstract=4645936
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    More about this item

    Keywords

    Inflation; science of monetary policy; output gap; unemployment gap; vacancy ratio; inflation expectations; wage-price spiral; non-linear Phillips curve.;
    All these keywords.

    JEL classification:

    • E0 - Macroeconomics and Monetary Economics - - General
    • E5 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit
    • E6 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook
    • E62 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Fiscal Policy; Modern Monetary Theory
    • O23 - Economic Development, Innovation, Technological Change, and Growth - - Development Planning and Policy - - - Fiscal and Monetary Policy in Development
    • I12 - Health, Education, and Welfare - - Health - - - Health Behavior
    • J08 - Labor and Demographic Economics - - General - - - Labor Economics Policies

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