The Inflation-Based ‘Natural’ Rate of Unemployment and the Conflict Over Income Distribution

Abstract

In reviewing modern inflation theory H.Frisch (1980) in particular presents a monetarist model which — in a way that is comparable with Vanderkamp’s (1975) and Dornbusch and Fischer’s (1978) treatment of monetarist ideas — allows an analysis of the interaction among the growth rate of money supply, the growth rate of real income and the rate of inflation. In a revised presentation of this model [see Frisch and Hof (1981, pp.158f.)] it is no longer maintained that this textbook version of inflation and unemployment is “exclusively’monetarist’ because the quantity equation is linked with the real sector through the Phillips curve and Okun’s Law.” In contrast to this revised characterization of Frisch’s model, we shall, however, continue to call it a ‘monetarist standard model,’ because its Phillips curve in particular is essentially ‘monetarist’ in spirit, since it is based on the so-called natural rate hypothesis. This hypothesis claims that there is a stable relationship between deviations from monetarist ‘natural’ unemployment (which is exogenously given) and unanticipated inflation. Furthermore Okun’s Law as it is used in this model is based on a given growth trend of potential output, which is an important ingredient in proving several ‘monetarist’ assertions including the belief in the asymptotic stability of the private sector. Frisch and Hof’s (1981) model thus not only summarizes some important results of the so-called ‘monetarist debate,’ but also includes important components of the monetarist view of the economy. This justifies our designation of this model, despite the fact that today’s monetarists may prefer more complicated transmission mechanisms of monetary impulses as well as formally different structural equations — as e.g. a Lucas supply function — with regard to deviations from ‘natural’ unemployment to derive Frisch and Hof’s results [cf. the end of section 2]

The author wishes to thank K.Dietrich, M.Krüger and M.J.M.Neumann for helpful criticism and comments.