Norman P. Obst

Stabilization Policy with an Inflation Adjustment Mechanism

I. Introduction, 355.—II. A basic model, 355.—III. A model with unemployment, 357.—IV. Conclusion, 358.

Stabilization Policy: Response and Extension

In my stabilization policy paper [Obst, 1978] two results were demonstrated within the context of a simple model. First, a constant rate of growth of the money supply leads to a trade cycle (of constant amplitude) in the rate of inflation and in the unemployment rate.1 Second, a feedback money supply growth rate rule determined so that monetary growth varies inversely with changes in the inflation rate (independently of the level of the inflation rate) can both lower the inflation rate to any predetermined equilibrium level and return the economy to full employment, thus stabilizing the model. Professor Martin, in his comment [Martin, 1980], is concerned solely with the constant amplitude of the cycles generated with a constant money supply growth rate. By specifying an ad hoc adjustment mechanism for output, he is able to obtain convergence under restricted parameter values. This type of result suggests the need, in comparing policy rules, not only to verify that an activist monetary growth rule produces stability, but also to demonstrate explicitly that it can also either improve other cycle characteristics or eliminate cycles and result in monotonic convergence to equilibrium. In what follows, it will be shown that the above monetary growth rate feedback rule, if pursued with sufficient vigor, will lead to convergence without cycles in my original models and will also eliminate the trade cycle in Martins own model. Subsequently, several defects in Martins comment will be examined. It will be argued that Martins output adjustment equation is not correctly specified. It should logically involve the stock excess demand function rather than his flow