The Sainthood of Central Bankers

[paul davidson <pdavidson@xxxxxxx>]

At 12:28 PM 5/22/03 , you wrote:
The Federal Reserve is very nervous about deflation.  The reason for this
is more than its awarenes of the grave danger of deflation on the
economy.  The real reason is is that central banks in general, and the Fed
in particular, do not have the power or operative measures within their
discourse to deal with deflation. The exclusive dependence of central banks
on interest rate policy to fight inflation does not work for fighting
deflation, as a decade of data in Japan has shown. The Fed is now following
Japan's lead in trying to manage an exchange rate policy (talking is not
pushing the dollar down) to export deflation to its trading partners.


This is a result of the 1970s Monetarist triumphant claim (and the American
Neoclassical Keynesian failure to refute)  that monetary policy was the
only game in town -- and that fiscal policy was futile!  Why was this
so?  Because both monetarists and Old and New Keynesians accept the
neutrality of money axiom as relevant -- at least in the long run.
Consequently the Od --and later the New Keynesians logical theory could
only explain unemployment as due to sticky wages and prices. Once enough
unemployment of sufficient duration was experienced, Monetarists such as
Milton Friedman in essence argued, wages would fall ( -- or at least rise
by no more than productivity gains) , therefore inflation would be
conquered and Say's Law would return as the CB lowered interest rates to an
amount equal to the marginal productivity of capital at full
employment.  Say's Law would be established and the central banker would be
elevated to sainthood by the Pope.

Unfortunately the neutrality of money axiom is equivalent to the axiom of
parallels in a non-Euclidean world--- and such fiction therefore is not
applicable to a world of falling prices, when there exists the institutions
of money and money contracts to organize production and exchange
processes.  Hence the evidence just shows what  Aesop's fables the theories
based on the neutrality of money are.

Paul Davidson
Louise Davidson
Editorial Office Manager
JOURNAL OF POST KEYNESIAN ECONOMICS
SMC 501
Department of Economics
University of Tennessee
Knoxville, Tennessee 37996-0550
phone: (865) 974-4221
fax: (865) 974-1686