Here’s Carola Binder:
In the New York Times, Binyamin Applebaum writes that Stein’s speech “underscored that the Fed increasingly regards bubbles, rather than inflation, as the most likely negative consequence of its efforts to reduce unemployment by stimulating growth.” In fact, the Fed’s concern about bubbles is not so new. After the Great Depression, it was widely believed that the stock market overheated in the 1920s, leading to the Great Crash in 1929 and the onset of the Depression. In those days, the word for bubbles or overheating was speculation, and it became a dirty word indeed. After the Great Depression, speculation remained a major concern of the Fed. The Fed very explicitly regarded bubbles as the most likely negative consequence of its efforts to reduce unemployment by stimulating growth.
For example, the United States economy was in a recession in 1953-54. In 1955, as the economy was recovering, the minutes from the Federal Open Market Committee refer multiple times to concerns about “speculative developments” or “speculative excesses.”
Yikes, it’s happening even sooner than I expected.
Governor Strong targeted prices and output in the 1920s, and opposed attempts to stop the stock market bubble. After he died in 1928 the Fed ratcheted up rates until they drove the economy into depression. The Fed blamed the Depression on speculative excesses because . . . well . . . because otherwise it would be their fault. And that’s just not possible.
Ms. Binder then explains that the old fogies were still in charge of policy as late as the early 1950s, but by the 1960s the Depression generation took over:
In 1958, William Phillips published “The Relation between Unemployment and the Rate of Change of Money Wage Rates in the United Kingdom.” This really kicked off the now-common idea that inflation is the most likely negative consequence of the Fed’s efforts to reduce unemployment. If the Fed is now starting to regard bubbles, rather than inflation, as the most likely negative consequence of its efforts to reduce unemployment, this is not a new trend. It is history of thought repeating itself.
This generation rightly ignored bubbles, and oddly (or not so oddly if you understand Market Monetarism and the EMH) they did not create any major bubbles despite a single-minded focus on easy money and jobs. Unfortunately they also ignored inflation and NGDP growth, which was a big mistake. Of course they blamed the Great Inflation on fiscal stimulus, unions, OPEC, wheat prices, and Peruvian anchovy production (I kid you not), even though none of those things had anything to do with 11% NGDP growth from 1972 to 1981, and indeed fiscal policy was not even expansionary. But what other choice did the Fed have? One could hardly expect them to blame themselves.
By 2006 the “Great Inflation” generation was in charge of monetary policy. They quite rightly ignored bubbles, and they quite rightly saw the need for a nominal anchor. At least they did so until they were distracted by the Great Financial Crash, when they let money get so tight that NGDP growth expectations plunged into negative territory. There were probably several reasons for this policy failure, including an excessive reliance of backward-looking Taylor Rules, and too much focus on inflation rather than NGDP growth. Of course they blamed the Great Recession on excessive speculation, and how could you blame them? Otherwise they would have to acknowledge that money was way too tight in 2008-09, and that the Fed caused the Great Recession.
And so now we come full circle. Do DSGE models incorporate Nietzsche’s Eternal Return?
PS. Last week I attended a conference on the Great Depression at Princeton. All the other participants were from elite schools, and they included historians, political scientists, and economists. I noticed that many non-economists don’t share our view that the Depression was caused by tight money and that the Great Inflation was caused by central banks printing lots of money. In fairness, I’m even more ignorant of fields like history than they are of monetary economics.
PPS. Stephen Brien sent me this link, showing that starting in April the UK government will have real time data showing the entire nominal wage bill of the British economy. Let’s hope they post it online, where it would provide invaluable real time information on the state of the British economy (a subject of great confusion today.) Indeed in some ways this data is even more useful than NGDP, which is distorted by declining North Sea oil output, a trend that has little impact on employment.