The Sumnerian Phillips curve

In my previous post ”Dude, here is your model” I suggested to model the supply in the economy with what I called a Sumnerian Phillips curve in a attempt to help Scott Sumner formulate a his ”model” of the world.

Here is the Sumnerian Phillips curve:

(1) Y=Y*+a(N-NT)

Where Y is real GDP and Y* is trend growth in real GDP. N is nominal GDP and NT is the central bank’s target for nominal GDP. a is a constant.

Commentator ”Martin” has suggested the following parametre for (1):




It should be noted that Martin formulates (1) in growth rates rather than levels.

As the graph below shows Martin’s suggestion seems to fit US data very well.

One thing is very clear from the model. The Great Recession was caused by a sharp drop in NGDP. The Fed did it. Nobody else.

It also shows that there is no supply side explanation for the Great Recession. The drop in real GDP can be explained by nominal GDP. It is very simply. Too simple to understand maybe? If you disagree you have to argue that the Fed can not determine nominal GDP – may I then remind you that MV=N=PY. Or maybe we should ask Gideon Gono?

So what are the policy lessons?

Well, first of all if the central bank keeps N growing at a rate comparable with the target then real GDP growth will also remain stable. But if the central bank allow N to drop below target then Y will drop as well. Hence, recessions are always and everywhere a monetary phenomenon.

Obviously the central bank can determine N as we know that MV=N=PY. So it is really pretty simply – ensure a growth rate of the money supply (M) that for a given money-velocity (V) ensures that N growth at a stable rate. Then you sharply reduces the risk of recessions and and you will ensure low and stable Inflation. The Federal Reserve did that during the Great Moderation and I can not see any reason why we can not return to such a situation. Unfortunately central bankers seem to have less of an unstanding of this – particularly in Europe (Is it only me who fell like screaming!?)

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