Knowledge that Transforms

Any test of the monetary approach centered on the period of fixed exchange rates would now be predominantly of historical interest. At the time of this study, however, experience with flexible exchangc rates was still too short to permit concentr.ating econometric analysis exclusively on this more recent system. Caught in this net, we have attempted an analysis of official reserves and the foreign exchange rate in lIr;unce covering both fixed and flexible exchange rates, that is, thirty-nine quarters of tixed rates, 1962.11971.3, and thirteen quartcrs of flexible rates, 1971.4-1974.4. cost is the presence of errors in our simultaneous equation estimates of the exchange rate during the period of fixed rates. But the benefit is an econometric analysis founded on fifty-two observations, and yet covering three years of flexible rates. Since the errors in the estimates of the exchange rate under fixed rates are quite moderate, the cost would seem to be worth the benefit. most important characteristic of our work is the use of a detailed structural model of bank credit and money in testing the monetary approach. early tests of this approach simplified the structure of the monetary to the utmost and considered the domestic source component of the reserve base (or the total base minus official foreign reserves) and the money multiplier as exogenous.' But there is really no logical basis for these restrictive assumptions. monetary approach states that the demand and supply of money in a small country together determine 1) money, and 2) official reserves or the foreign exchange rate or the attainable combinations of the two, depending upon fixed, floating, or managed exchange rates. Nothing but a correct specification of the conditions for monetary equilibrium can provide a basis for testing this proposition. We also deviate from the tendency in the literature on the monetary approach to suppose that any convenient measure of money will do. Based on this attitude, there have been many tests of the monetary approach using simply the reserve base as the measure of money, even though this aggregate, consisting of currency plus an arbitrary fraction of deposits, is inappropriate in analyzing the monetary behavior of firms and households.2 In justifying this measure in a well-known econometric work, Pentti Kouri and Michael Porter nmerely say: The essential features of the model [would not be] substantially changed by incorporating a more complete banking system (p. 448). But not only does this fail to meet the criticism, it also neglects the fact that the monetary approach can give rise to conflicting estimates of changes in official reserves and the exchange rate depending on the money measure.3 There is no way of assessing the seriousness of this last objection without testing. In this work we shall examine the extent to which varying and tenable money measures in France yield convergent results. In spite of these deviations from the literature, we may be said to adhere to a strict

In this note the possibility is demonstrated that a movement between a broadly based income tax and a consumption tax in a two-period consumption loan model can be completely accommodated by interest rate changes which leave real intertemporal consumption plans unchanged. Income and consumption taxes are both broadly based taxes, the former taxing all potential consumption in any period and the latter actual consumption. Lenders and borrowers face the same prices under both tax regimes and movements between the two can, in this simple model, be wholly accommodated by interest rate changes leaving intertemporal consumption plans unaffected. This result contrasts with the conventional argument in favor of a consumption tax in preference to an income tax on the basis of lack of distortion of savings behavior. It is not suggested that because of this result exact monetary accommodation to consumption income tax variations will occur in all circumstances, but it seems to be of interest to note that such adjustments are possible and these appear not to have been previously considered. The traditional argument for the distorting effects of an income tax over a consumption tax is often made in a simple two-period intertemporal consumption choice model. If an individual receives income Y,, YK in each of two periods and if the interest rate is r, then, so the argument goes, the slope of an individual's budget constraint between current and future consumption (C, and C2) is not disturbed by a consumption tax, whereas it is under an income tax. If interest is both taxable as a receipt and deductible as an expense under the income tax, and the marginal tax rate t is assumed to apply under both the income and consumption tax,' the slopes of the consumer budget constraint under the three alternative regimes are

Edward Ray, in his comment on my 1976 paper, analyzes a slightly different model than the one I presented, and thus reaches different conclusions. His principal conclusions are that: (i) given wage rigidities, a wage subsidy to producers is needed, and this subsidy is equivalent to the optimal static subsidy that ensures full employment in each sector; and (ii) given the forced equilization of wages across sectors, a subsidy to workers is needed to encourage labor transfers between sectors. Thus, Ray finds that full employment is always desirable, whereas I find that some unemployment is (usually) present along the optimum path.

The achievement of full employment or, as it is sometimes presented, the minimization of unemployment has been a major goal of public policy since the economic cataclysm of the 1930's. This goal reflects the implicit belief among policymakers that achieving full employment is the appropriate concern of a manpower policy responsive to the needs of individuals and society. This perception, along with the labor force concepts used to measure progress toward the full-employment objective, has its origin in the surroundings of the depression era and the Keynesian revolution. The events of this period, marked by mass unemployment and related economic hardship, and their conception in economic theory continue to shape contemporary economic policies and labor force concepts. What proved to be an adequate measure for one set of perceived problems may prove to be inadequate for another, necessitating a change in concepts or methods of measurement. In particular, the relevance of depression era policies and labor force concepts to the present is a question of major importance. Current surroundings have changed, with the growth of income transfer programs and multiple earner families weakening the link between unemployment and economic hardship. As the surroundings have changed, so has economic theory. Led by the resurgence of neoclassical theory and the development of neo-Marxist theories of segmentation, the perception of unemployment and its causes has changed over time. This paper traces the evolution of economic theory and events, and their impact upon labor force concepts. The relationship of current concepts of employment and unemployment to Keynesian theory and events of the depression era is described and the implications of post-Keynesian theories for these concepts explored. The argument is advanced that current labor force concepts lag behind contemporary economic theories and events. Some directions for change are suggested.