Michael Roberts — The monetary dilemma

by
Mike Norman
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According to the minutes of the last meeting of the monetary policy committee of the US Federal Reserve Bank, the most powerful monetary authority in the world, the committee members are split and unclear on what to do. “Some participants who counselled patience expressed “concern about the recent decline in inflation” and said the Fed “could afford to be patient under current circumstances.” They “argued against additional adjustments” until the central bank was sure that inflation was on track. On the other side, more hawkish members “worried about risks arising from a labour market that had already reached full employment and was projected to tighten further…..backing off from a steady diet of rate hikes could cause the Fed to overshoot its employment target and cause financial instability”, they said.

The problem is that the Fed’s economic models were failing to provide guidance on what to do. The current mainstream model has two strands. The first is the Wicksellian idea that there is a ‘natural rate of interest’ that brings a capitalist economy into harmonious equilibrium where economic growth and full employment and stable and low inflation are combined. The Fed calls this R*. The second is the Keynesian view that there is a trade-off between unemployment and inflation, so that as an economy heads towards ‘full employment’, this drives up ‘effective demand’ beyond any ‘slack’ in supply in the economy and so wages and price inflation ensues. This is enshrined empirically in the so-called Phillips curve, named after a British economist of the 1960s.