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Price Level Stabilization Experiments Using the Dynamic Phillips Curve Concept
Abstract
This paper deals with the price-level stabilization issue from a monetarist point of view. Government fiscal action is assumed to be ineffective without corresponding monetary actions. The price-level stabilization is studied here using the dynamic econometric model developed by the St. Louis Federal Reserve Bank and, employing a linear parameterised control law, optimized monetary policies are found which drive the economy to specified target inflation rates. The economic response is described in terms of dynamic Phillips curves and the tradeoff between short term unemployment and long term stabilized inflation rates is given. The control solution indicates that optimized monetary policy should be initially contractionary, followed by a mild expansionary phase. There is a short term rise in unemployment which is the price paid for stabilized low inflation rates.
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In this study, the econometric model used by the Federal Reserve Bank of St. Louis to provide information on the most likely movement of strategic economic variables in response to monetary and fiscal actions is viewed as a control system. Government expenditure is viewed as an uncontrolled disturbance, while change in the money stock is viewed as the input control variable. Quarterly change in the money stock is treated as a linear function of errors in economic variables from established target values. A numerical gradient scheme is then applied to the proportionality constants of the function so as to minimize a quadratic performance index. Throughout the study, the nonlinear system equations are retained. The results of this study indicate that automatic control of the money stock by this method would have improved the nation’s economy over the last fifteen years.