Early in my blogging career I did a post entitled “My Role Model, George Warren.” Warren was the brains behind FDR’s dollar depreciation program of 1933 (Irving Fisher was also a proponent of the policy.) Here’s a portion of the post:
One reason FDR abandoned the program is that many economists told him that the devaluation was already plenty big enough to restore the 1926 price level. They said that gold would flood into the U.S. after the gold standard was restored, and the monetary base would soar. They were right about the gold flows and the base, but not about commodity prices. Only Warren understood that the rational expectations hypothesis implied that expected future growth in the money supply was already embedded in commodity prices, and the markets were telling FDR that more inflation was needed. Here is a quotation from Warren’s personal notes a few months later (describing FDR’s disappointment when commodity prices stopped rising in 1934):
“The President (a) wanted more inflation and (b) assumed or had been led to believe that there was a long lag in the effect of depreciation. He did not understand-as many others did not then and do not now-the principle that commodity prices respond immediately to changes in the price of gold.”
I don’t have the data at home, but I believe the WPI rose over 20% during the devaluation, and then only another 5% or so between 1934 and mid-1940.
Today it seems like the Fed is just waiting around to see if their low interest rate policy will work. And pundits endlessly debate whether the fiscal stimulus package will succeed. As far as I’m concerned the verdict is already in. What matters for policy is not whether something “will work,” but rather whether the optimal forecast suggests it is expected to work. As Lars Svensson (another guy recently praised by Krugman) emphasizes, policy should adopt a stance that it expected to hit the policy goal. Right now the stock, commodity, and bond markets are signaling that the current policy stance is woefully inadequate. Indeed, even the Fed’s internal forecast suggests that we will fall short of their own implicit target.
Four years later and the Fed is still behind the curve. But this example reminds me of Japan in 2013, which has been following FDR’s playbook—reflation through currency depreciation. They’ve done a lot already, and it will help. But I’m inclined to agree with Charles Dumas in the Financial Times, it’s still not enough:
At just over Y100 to the dollar the yen is cheap enough to get Japan’s economy back to its trend level from 2.5 per cent below it, with growth of 3 per cent this year and perhaps 1 per cent in 2014, and to eliminate deflation. Sharp increases in import costs could raise CPI inflation to 2 per cent (the new long-run target) by year-end or early 2014, but domestic costs are now still falling. That may stop by the end of next year, but CPI inflation could also fall back to zero unless there is a further yen devaluation, perhaps to Y120 versus the dollar. Inflation of 2 per cent is unlikely to last with the measures adopted so far.
A hundred yen to the dollar will deliver some growth—but if they are serious about getting domestic reflation they probably need an even sharper currency depreciation. Japanese bond yields are still too low.