On 5 November, David Vines gave the first of a series of lunchtime talks by CEPR Research Fellows. These will present a wide range of the policy-related research done by the Centre's Research Fellows. The meetings are open - for details, see Forthcoming Events. Any specific policy views are those of the speaker rather than CEPR, which takes no institutional policy positions.

Based on his ongoing work on macroeconomic policy design, Vines proposed a new macroeconomic strategy for the UK. He argued that British macroeconomic policy could not by itself resolve two fundamental problems facing the British economy, the magnitude of the present world slump and Britain's slow rate of technical progress compared with most of her competitors in the post-war period.

Vines's proposals are intended to ameliorate the unemployment and inflation or "stagflation' caused by these two fundamental problems. The strategy he described had three basic elements: "conditional' reflation, an incomes policy designed to promote employment, and carefully specified responsibilities for fiscal and for monetary policy.

Vines argued that inflation in the UK was held down at present by two factors, the level of unemployment and the belief that government policy will not allow inflation to rise in the future.

The level of unemployment may be so high that even a large stimulus to labour demand would not by itself cause inflation to re-emerge. So why not expand demand? Many observers, according to Vines, believe that such an aggregate demand expansion will not bring about an increase in employment. Reflation would merely destroy the expectation of low inflation in the future and thus destroy the credibility of anti-inflation policy. This would revive inflation, yet unemployment would not fall from its present high level.

Vines argued that reflation must be "conditional' in order to reduce unemployment and at the same time maintain the credibility of anti-inflation policy. He described a policy of conditional reflation, in which the government would announce a "norm' or target rate of inflation and a fiscal stimulus. At the same time it would also announce that if inflation were to rise above the "norm', then the pace of reflation would be slowed and thus employment would grow less rapidly. In their book [f]09Demand Management , Vines and other "New Keynesians' proposed one form of conditional reflation, in which the government would announce a medium-term target path for nominal or money incomes.

Vines then outlined the second element of the strategy. Income- fixing institutions should be reformed so as to promote employment. He noted that such reforms have been discussed in James Meade's book Wage Fixing . There would be no centralized regulation of wage fixing, but there would be a central body which announced the norm or guideline rate of pay increase. There would also be tax incentives to promote employment, as advocated by Richard Layard. An essential feature of the policy would be arbitration in pay disputes, the duty of the arbitrators being to promote output and employment. Vines also suggested that profit sharing, as proposed by Martin Weitzman, should also be considered.

Demand management, Vines stressed, requires striking a balance between fiscal and monetary policy. He and other "New Keynesians' argue that fiscal and monetary policy should each be assigned a specific role. Fiscal policy would be used primarily to control the rate of growth of nominal or money incomes. Monetary or interest rate policy would be used primarily to stabilize the exchange rate, and so help stabilize UK competitiveness. How would the desired level of competitiveness be determined? Vines argued that the target level of competitiveness should be gradually adjusted so as to alter the balance between spending on consumption and investment (both home and foreign) as desired.

Vines argued that using monetary policy in this way would have two important benefits. It would limit the swings in UK competitiveness compared with those which occur when monetary policy is devoted soley to an domestic objective (e.g. in the UK from 1979 to 1981 and in the US from 1982 to the present). It would not jeopardize the management of nominal or money incomes since this would be achieved by fiscal policy. Rudiger Dornbusch has argued that this would not be possible in the US, where fiscal policy is much less flexible, but Vines contended that the UK situation would be different.

There was a lively discussion of Vines's proposed strategy. Was nominal income targeting practical? It was argued that the national income statistics were produced too slowly to allow nominal income to be used as a policy target. Vines conceded this difficulty, countering that more attention should be given to the timely production of these data.

The "New Keynesian' strategy was characterized in the discussion as a return to the policies of the 1960s. Vines replied that his strategy assigned fiscal policy control of nominal, not real demand, and that monetary policy would not steer the exchange rate towards the high level of the 1960s, but rather towards an appropriate level of competitiveness. Moreover, "conditional' reflation would not accommodate rises in wages, as had occurred under earlier policies.

Vines concluded his talk by describing the current research of the "New Keynesian' group, designed to investigate the question of "policy assignment' in more detail.