Discussion Paper Details

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Title: Macroeconomic Policy in the Presence of Structural Maladjustment

Author(s): Robert J Gordon

Publication Date: October 1996

Keyword(s): Budget Deficit, Labour Markets and Monetary Policy

Programme Area(s): International Macroeconomics

Abstract: This paper analyses two-way interactions between structural reform and macroeconomic policy. If structural reforms increase the flexibility of labour markets, they are likely to improve the short-run inflation-unemployment trade-off, providing an incentive for policy-makers to expand aggregate demand. In turn, the promise by policy-makers that they will encourage a decline in unemployment in response to good news on inflation can be used to strike a political deal with political interests opposed to the introduction or extension of structural reform. Expansionary monetary policy also provides relief on the fiscal front, directly, by bringing the actual budget deficit closer to the structural budget deficit, and indirectly, by encouraging structural reform, potentially reducing the structural budget deficit itself. In 1992?3 several European countries dropped out of the ERM to pursue more expansionary monetary policies. The difference in the performance of these countries and those that maintained a peg between their currencies and the Deutsche mark provides an important test case of the consequences of expansionary monetary policy. The depreciating nations by 1995 enjoyed a substantial relative acceleration of nominal GDP and, surprisingly, an even greater deceleration of inflation, so that their growth rate of real GDP accelerated more than their growth rate of nominal GDP in relation to the pegging countries. The continued deceleration of inflation in the depreciating countries provides evidence that their natural unemployment rate has declined and that expansionary monetary policy has interacted beneficially with structural reform.

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Bibliographic Reference

Gordon, R. 1996. 'Macroeconomic Policy in the Presence of Structural Maladjustment'. London, Centre for Economic Policy Research.