If it quacks like an ultra-conservative central bank . . .

Paul Krugman recently contested my argument that Japan is not stuck in any sort of deflationary trap.  Ryan Avent already showed why Krugman doesn’t have much of an argument:  

And…I’m genuinely mystified. The only thing I can think of that would square this circle is if Mr Krugman and I are using different definitions of the word “prefer”. As best I can tell, he has conclusively shown that Mr Sumner is right, and Japan hasn’t been in a deflationary trap. It just needs to fire all of its central bankers.

I’m not surprised that Krugman wants to claim the BOJ is stuck in a deflationary trap; he published the best model we have to explain why that might happen.  But I’m afraid it didn’t happen, and although Avent’s post is pretty definitive, even he didn’t address all of the problems with Krugman’s argument. 

Let’s start with his response to my admission that my view is the minority view:

He guesses right: that’s not at all the view of those who have been following Japanese monetary policy since the 1990s, and have even talked to BOJ people now and then.

So Bank of Japan officials are not publicly admitting to favoring mild deflation.  Is that really surprising?  And regarding “those who have been following Japanese monetary policy since the 1990s” (does that include me?), I was under the impression that many of them were highly critical of Japanese monetary policy for being too contractionary.  That sort of criticism of the BOJ is hardly consistent with the view that the Japanese are “stuck” in some sort of deflationary trap.

As far as I can tell, the Fed has an implicit target of roughly 2%, maybe a bit less.  The ECB is about the same, perhaps a bit lower.  The BOJ has target of stable prices, which means zero inflation.  I don’t know what inflation index they use, but their CPI has been amazingly stable since February 2002 (roughly when the QE started.)  The CPI was 100.1 on February 2002, and is now 99.7.  That’s a grand total of 0.4% deflation over a period of 8 years!  Price stability just doesn’t get any better than that.  Other that a few months in 2008, when oil prices soared, the Japanese CPI never moved more than 1% up or down from the February 2002 figure.  (BTW, the Bullard study that I was commenting on looked at 2002-10 data.)   If you don’t like my February 2002 starting point, the Japanese CPI has fallen by a grand total of 0.5% since June 1993, a period of 17 years.  Not per year—total.  So if the CPI is their target, then the Japanese just might be the most skilled central bank in all of world history.  Who else has produced such absolute price stability!

Now I will admit that the core inflation rate shows a bit more deflation, but it’s still pretty close to price stability.  (Eyeballing the graph in the Bullard paper, it looks like about 0.3%/year deflation since 2002.)  So the BOJ really isn’t very far off target, even if you use the core rate.  But let’s take the worst case, and assume the BOJ prefers stable prices to very slight deflation.  I still think Krugman is wrong.  And the reason is that the BOJ abhors positive inflation like a vampire fears sunlight.  So when there is any sign of inflation, the BOJ immediately does something contractionary.  They always err on the side of mild deflation, even if their first best choice is precisely zero inflation.  

Krugman points to the large increase in the monetary base during the early 2000s, but skims over the big drop in 2006, indeed doesn’t even consider it to be that dramatic.  I’d consider a drop of over 20% from peak to trough to be pretty dramatic, as far as I know it is larger than any monetary base drop experienced by the US in the past 100 years, including the Great Deflation of 1920-21.  But let’s say Krugman’s right and that it’s no big deal; that still doesn’t explain why it occurred.  The explanation seems obvious to me; the BOJ was terrified that after years of very mild core deflation, they might have 1% inflation.  So they tightened monetary policy, just as you’d expect a central bank to do if it wasn’t “trapped.”

Krugman also argues that depreciating one’s currency is not as easy as it looks, and points to the Swiss case.  First of all, I think we both agree that there is no technical barrier to depreciating a currency; the central bank can offer to sell unlimited amounts of its currency at a lower value than the current exchange rate.  The risk Krugman refers to is that they might have to buy up a lot of assets, and then later sell them off to prevent an outbreak of inflation (with a risk of capital losses.)  That’s a fair point, but it probably applies more to a small country whose currency is a popular safe haven, than to Japan.  It’s hard for me to believe that the sort of monetary base increase required to depreciate the yen would expose the BOJ to unacceptable risk of capital loss.  And if it did, it begs another question; if they don’t want a big and volatile monetary base, what the heck are they doing setting a zero inflation target?  A two or three percent inflation target will result in a much lower monetary base to GDP ratio, and probably a more stable one as well.

So here is where we are:

1.  The Japanese are supposedly stuck in a deflationary trap, even though their CPI has been amazingly close to their zero long run inflation target.

2.  Even the core CPI shows only exceedingly mild deflation

3.  Every time the rate of inflation threatened to break above zero, the BOJ tightens monetary policy.

4.  It’s known that temporary currency injections are ineffective, but the BOJ nonetheless sharply reduced the base in 2006 only a few years after doing QE.

5.  The BOJ refuses to set a 2% inflation target, like normal central banks.

How in the world is all that not consistent with a central bank that officially targets zero inflation, but would prefer a bit of deflation to a bit of inflation?  And since absolutely perfect price stability is a practical impossibility, didn’t the BOJ get the mild deflation that they clearly prefer to mild inflation?  So what precisely is the problem?  Where is the policy failure?  I just don’t see it.

Sometimes I think you need to stand back and look at how policymakers act, not what they say.  For example, every time President Carter or President Clinton put out feelers about normalizing relations with Cuba, Castro would commit some outrage, to undercut the initiative.  At some point don’t you have to ask yourself whether Castro really wants 100,000s of rich Cuban-American tourists flaunting their wealth, buying up hotels in Havana.  How long would communism last if Castro couldn’t use the trade embargo as an excuse?   (Which is precisely why an anti-communist like me has always been opposed to the embargo.)

My hunch is that if Krugman was sitting around a poker table with his former colleagues Svensson, Bernanke and Woodford, having a few beers, they wouldn’t be talking about how sorry they felt for the poor BOJ officials, unable to escape their quicksand-like deflationary trap.  The only debate would be over whether they were incompetent buffoons or evil reactionaries.  (I believe they are well-intentioned reactionaries.)

I’ll grant Krugman one very important point.  He was one of the first to point to the conservative nature of modern central bankers, and how their strong desire to maintain a reputation as inflation fighters threatens to drive the world into deflation (or at least disinflation.)  It looks like Krugman might have been right.  But I’m not willing to grant them a sort of “central bankers will be central bankers” excuse.  The world shouldn’t have to spend trillions on fiscal stimulus just because central bankers have made a fetish of stable prices.

Believe me, if you put 12 Paul Krugmans on the BOJ policymaking board, you’d get inflation.


Tags:

 
 
 

29 Responses to “If it quacks like an ultra-conservative central bank . . .”

  1. Gravatar of Bob O’Brien Bob O'Brien
    30. July 2010 at 18:03

    Since the BOJ has been doing a good job of managing NGDP, then there must be other reasons why the Japanese economy has shown such poor RGDP growth over the last 10 years. Say the fed sees the light and takes Scott’s NDGP advice, what are the chances that Japanese style slow RGDP growth would still happen in the USA?

  2. Gravatar of Morgan Warstler Morgan Warstler
    30. July 2010 at 18:27

    “The world shouldn’t have to spend trillions on fiscal stimulus just because central bankers have made a fetish of stable prices.”

    We didn’t have to. And there are many ways to make sure it can’t happen again. If we have a balanced budget amendment, we won’t be able to. With a single world currency, we won’t be able to. And if it comes to it (unfortunately) with a high enough debt, we won’t be able to. Why do you really think Greenspan said we needed deficits from Bush, after Clinton?

    Because without them, our republic would have no insurance against the willfulness of democracy.

    “Believe me, if you put 12 Paul Krugmans on the BOJ policymaking board, you’d get inflation.”

    Yah, we’d get the same thing out of 12 Sumners. How exactly are you better than him again?

  3. Gravatar of Ram Ram
    30. July 2010 at 18:40

    Trap-style explanations of deflation in Japan (or below-target inflation in the U.S.) sidestep the problem of explaining the motivations of central bankers. This is perhaps why Krugman favors them over your explanation. The evidence you provide does seem to be consistent with the theory that the BOJ (or the Fed) is mostly producing the results that it wants to produce, whatever else it may suggest in its public statements. Nevertheless, it remains to be explained why these bankers want what they seem to want, given that it flies in the face of what textbook economics recommends under the circumstances.

    You write that the BOJ is run by ‘well-intentioned reactionaries’, but that is not very persuasive. You also write that modern central bankers have a ‘conservative nature’, but that too strikes me as hand-waving. If you’re right–if it is fully within the power of the Fed, for example, to return us to a self-sustaining expansion–it is really hard to see why they wouldn’t do just that. The closest you’ve come to providing a theory is your post on ‘opportunistic disinflation’, but what’s noteworthy about that theory is how nutty it makes the bankers out to be. What ever happened to the economic postulate that individuals make rational choices? I think you may well be right, but what I want to see is a compelling theory of why central banks make the sorts of decisions they do, compatible with everything else economists want us to believe about the world.

  4. Gravatar of marcus nunes marcus nunes
    30. July 2010 at 20:00

    Scott
    With regard to “LT” and MP, Krugman likes to play “Hot and Cold”, i.e, sometimes he says MP “works” sometimes he says it doesn´t (and you should concentrate on larger “stimulus”).
    To me the import of his post is that you have climbed a few steps on the “influencemometre”. To be debated on a “Wonkish Class” post by Krugman is a long way from his offhanded dismissal of your open letter to him in March 2009:

    OK, I see that Scott Sumner has written an open letter to me. But I’m puzzled. He writes:

    “I think you have acknowledged that there is some level of quantitative easing that would boost demand. If I am not mistaken you are concerned that if such a policy boosted inflation expectations sharply, the Fed would have to quickly sell off these assets, suffering massive capital losses.”

    Um, you are mistaken. I’ve never said such a thing. Did you mean to address this letter to someone else?

  5. Gravatar of marcus nunes marcus nunes
    30. July 2010 at 20:28

    @RAM
    Check this out (from 1937)
    …On May 1, 1937, the final leg of the tightening was completed. With that in place,excess reserves fell back to levels as low as had not been seen since several years earlier.

    May 1937 also marked the peak of the incomplete expansion from the Great Depression of 1929-1932. The economy promptly returned to recession. Though the extent of the sharp decline in activity was not immediately evident, by Fall it became fully clear to the Committee that the economy was thrown back to a severe recession, once again.

    The following evaluation of the situation by Williams at the November 1937 meeting is informative, both for offering a frank admission that the FOMC apparently wished for
    a slowdown to occur and also for outlining the case that the recession, nonetheless, had nothing to do with the monetary tightening that preceded it. Particularly enlightening is the reasoning offered by Williams as to why a reversal of the earlier tightening action would be ill advised.

    “We all know how it developed. There was a feeling last spring that things were going pretty fast … we had about six months of incipient boom conditions with rapid rise of prices, price and wage spirals and forward buying and you will recall that last spring there were dangers of a run-away situation which would bring the recovery prematurely to a close. We all felt, as a result of that, that some
    recession was desirable …

    We have had continued ease of money all through the depression. We have never had a recovery like that. It follows from that that we can’t count upon a policy
    of monetary ease as a major corrective. …
    In response to an inquiry by Mr. Davis as to how the increase in reserve requirements has been in the picture, Mr. Williams stated that it was not the cause
    but rather the occasion for the change. … It is a coincidence in time. …

    If action is taken now it will be rationalized that, in the event of recovery, the action was what was needed and the System was the cause of the downturn.
    It makes a bad record and confused thinking. I am convinced that the thing is primarily non-monetary and I would like to see it through on that ground.
    There is no good reason now for a major depression and that being the case there is a good chance of a non-monetary program working out and I would rather not muddy the record with action that might be misinterpreted. (FOMC
    Meeting, November 29, 1937. Transcript of notes taken on the statement by Mr.
    Williams.)

    Fisher is just being like John Williams (VP of the NY Fed, associate economist of the FOMC and a Harvard professor) in 1937

  6. Gravatar of Mike Sandifer Mike Sandifer
    30. July 2010 at 21:01

    I’m gonna go ahead and say you’ve won so far Scott.

  7. Gravatar of Lorenzo from Oz Lorenzo from Oz
    30. July 2010 at 22:43

    Morgan: Yah, we’d get the same thing out of 12 Sumners. How exactly are you better than him again?
    Not a claim I have ever seen Scott make. On the contrary, his debate with Krugman has been conducted in a remarkably civilised fashion.

    On why the BoJ has been behaving like it has, does the aging of the Japanese population have anything to do with it? Is this a giant exercise in making sure the savings of elderly Japanese retain their purchasing power?

    And is the behaviour of the Fed also connected to the where the baby boomers are in stage-of-life terms? After all, it has been the biggest factor in the social history of the US (and Anglosphere generally): the 1950s (the C20th’s unexpected decade) were all family-together-at-home because of raising all those kids; the 1960s was youth-oriented because that’s where they were: the 1970s was young-adults-with-money, the 1980s were folk-with-careers having fun, the 1990s were let’s-protect-our-kids, the 2000s was a mixture of reprising our Vietnam demo days (global warming & anti-Iraq) and worrying about retirement. So the future purchasing value of money really matters.

  8. Gravatar of himaginary himaginary
    30. July 2010 at 23:55

    “The only debate would be over whether they were incompetent buffoons or evil reactionaries. (I believe they are well-intentioned reactionaries.)”

    That reminds me of the following adage:
    “Sufficiently advanced incompetence is indistinguishable from malice.”
    http://en.wikipedia.org/wiki/Clark's_Law

  9. Gravatar of Bill Woolsey Bill Woolsey
    31. July 2010 at 04:36

    Bob:

    I favor keeping nominal GDP on a 3% growth path (in the U.S.)

    This should lead to a stable price level on average.

    The trend growth rate for real GDP in Japan was higher, and so a growth path appropriate for the U.S. would be mildly deflationary for the Japan.

    I would have favored something like a 5% growth path for Japan’s NGDP. And that should have led to stable prices on average.

    Scott’s article hear seems to be advocated 2% inflation. I am not sure why he considers that beneficial. Rapid real economic growth is consistent with stable prices.

  10. Gravatar of scott sumner scott sumner
    31. July 2010 at 05:15

    Bob, The US has been growing at roughly 3% a year for almost its entire history. Will it suddenly fall to 2% trend growth. Maybe. But that just means we get 3% trend inflation instead of 2%. Not the end of the world.

    Morgan, But the money is still being wasted, regardless of whether you say it doesn’t have to be that way.

    Ram, You said;

    “Trap-style explanations of deflation in Japan (or below-target inflation in the U.S.) sidestep the problem of explaining the motivations of central bankers. This is perhaps why Krugman favors them over your explanation.”

    There are two problems with this. First, Krugman doesn’t sidestep motivations, his entire theory of “expectations trap” is based on the assumption that central bankers have very conservative motivations.

    Second, you can’t talk about a “trap” without considering motivations. It implies not just a period of deflation, but also central banks that are trying to escape the deflation. If they want the deflation, there is no “trap” to be modeled.

    You said;

    “Nevertheless, it remains to be explained why these bankers want what they seem to want, given that it flies in the face of what textbook economics recommends under the circumstances.”

    Since when do our macroeconomists pay any attention to textbook models? When the economy was falling off a cliff in September/October 2008 I was screaming for easier money (rates were still well above zero, BTW) and I couldn’t get any other economists interested. They didn’t seem to see monetary policy as being too tight. How does that fit in with textbook models? The blogger Arnold Kling claims I am the only blogger who is standing up for textbooks models in this crisis. Obviously that’s a bit of hyperbole, but there aren’t many. Lots of economists are calling for the Fed to raise rates.

    You said;

    “You write that the BOJ is run by ‘well-intentioned reactionaries’, but that is not very persuasive. You also write that modern central bankers have a ‘conservative nature’, but that too strikes me as hand-waving.”

    I think you misread the conservative banker comment, that was a reference to Krugman’s views.

    Ram, You said;

    “If you’re right–if it is fully within the power of the Fed, for example, to return us to a self-sustaining expansion–it is really hard to see why they wouldn’t do just that.”

    Have you been reading the comments of Fed officials? They themselves acknowledge that there are more things they could be doing, but they also state they they don’t want to because they don’t see a need for more AD. They like the low inflation we are experiencing, and don’t want to raise it. (Not all, but enough to block Fed action.)

    You said;

    “The closest you’ve come to providing a theory is your post on ‘opportunistic disinflation’, but what’s noteworthy about that theory is how nutty it makes the bankers out to be.”

    It may be a nutty theory, but a number of Fed officials have publicly embraced it.

    I do understand where you are coming from here. It is a puzzle that central bankers are doing this. I think most are well-intentioned. But they’ve done it before. They could have stopped the Great Depression, and they could have stopped the Great Inflation. Most economists agree with me on those two points. In time I believe my view of this crisis will also be accepted.

    marcus, Yes, he links to me more often, but never the 75% of my posts he’d agree with. With other bloggers, he links to posts he agrees with. Hours after my Plosser post he did a similar one without mentioning me. It doesn’t bother me, I just find it interesting.

    marcus#2, I’m going to do a post on that. Do you have a source?

    Thanks Mike

    Lorenzo, Yeah, I’ve said at least a dozen times that Krugman is a brilliant economist. He’s a Nobel-Prize winner, I teach at a small business school.

    I’ve heard those inter-generational theories, but I have a hard time seeing why policy could suddenly go so far off course on that basis. Perhaps it’s a contributing factor.

    himaginary, That’s a good line.

    Bill, I’m still with you on NGDP targeting, and was just referring to real world central banks here. I may do a post soon on the 3% NGDP target.

  11. Gravatar of marcus nunes marcus nunes
    31. July 2010 at 05:54

    Scott
    The quote comes from pages 12-13 of the paper:
    http://www.federalreserve.gov/pubs/feds/2004/200401/200401pap.pdf

  12. Gravatar of Ram Ram
    31. July 2010 at 06:40

    Scott,

    I didn’t mean to imply that expectations trap models ignore motivations, I just think that the motivations they stipulate are plausible — i.e., deflation is a very bad thing and ought to be stopped. If you don’t suppose a trap, you have to posit some other motivations, which means that central bankers in your story have to be OK with something that is pretty clearly not OK.

    I’m aware of the statements of Bernanke and others that there’s more they can do, but they’re not going to do it unless things get worse. One possible explanation is that, in fact, there is little more that they can do but they want to quash deflationary expectations by saying that they have the tools to prevent it and they will use them if necessary. This is consistent with the trap story, whether or not it’s true.

    If you don’t buy that explanation (I’m not sure that I do, given the credibility issues it raises), then it does seem like they ultimately want roughly what we’ve got, inflation-wise. But the question I have is why? Why would they suggest that they’re targeting higher inflation but then produce less?

    If your view is that only you (or you and a few others) are sticking up for the textbooks, then the problem generalizes: why are not only central bankers, but also economists in general, ignoring the stuff they teach to grad students? It’s fair enough to say that it has happened before, but that doesn’t explain why it happens.

    Again, I’m not necessarily disagreeing with you. I think you’re probably right, as a matter of fact. I’d just be more convinced if I had not only (1) a theory of what monetary policy should be right now; (2) a theory of what monetary authorities are actually doing right now; but also (3) why they’re doing (2) instead of (1). We often explain why politicians push for crazy farm subsidies in spite of their craziness by pointing to the farm lobby, etc. What I want is a comparable explanation for the Fed’s behavior. Are they catering to a particular interest group or constituency, rather than to the public interest? Or if they’re not, why do they keep making these mistakes again and again? They’re pretty smart people, after all.

  13. Gravatar of もしも超保守的中央銀行の様に鳴くのなら... スコット・サムナー 7月30日 –
    31. July 2010 at 07:02

    [...] [...]

  14. Gravatar of Bob O’Brien Bob O'Brien
    31. July 2010 at 07:06

    Bill & Scott:

    I have been reading this blog every day for a few months now in order to educate myself so I can better chart my way though these tough economic times. What I think I have learned is that the fed should target about a 5% future NGDP and the national government should minimize fiscal measures and then we will have the best chance for a stable 3% real growth with the least number of recessions. Thanks for the education.

  15. Gravatar of Jim Glass Jim Glass
    31. July 2010 at 07:41

    One thing I find a bit puzzling:

    If monetary policy is neutral as to the real economy in the long run, then how does a monetary policy that produces a rock-stable CPI for a decade, plus firm expectations of the same continuing into the future, knock an economy into a permanent state of semi-recession?

  16. Gravatar of Richard A. Richard A.
    31. July 2010 at 10:16

    It would be interesting to look at how smooth growing Japan’s nominal GDP growth has been in yen over the past couple of decades.

  17. Gravatar of Luis H Arroyo Luis H Arroyo
    31. July 2010 at 10:19

    The Monetary Base falling a 20%!!!!!
    I think Japan is a perfect example that price stability is incompatible with long term growth.
    But perhaps is a social choice, as in Germany.

  18. Gravatar of Doc Merlin Doc Merlin
    31. July 2010 at 13:13

    My current theory is that the Fed is illegally worrying about exchange rates and price of USD wrt other currency. The EU has been sending tightening signals and the chinese keep threatening to dump our currency, so they are preemptively tightening to keep the dollar strong.

  19. Gravatar of Doc Merlin Doc Merlin
    31. July 2010 at 15:30

    @Louis:
    The 19th century US example disagrees with you.
    Imo, Japan’s problem is massive fiscal debt, massive fiscal deficit, and a fertility rate under 2.

  20. Gravatar of Luis H Arroyo Luis H Arroyo
    31. July 2010 at 23:33

    @Doc Merlin,
    I don´t know why XIX century is not an example of succesive cicles of growths and contractions, until the “Great Contraction” of 1929. The prices were not stable, they went up and down. When they went up, GDP also rose; but when they falled , GDP also falled.
    Ther were not stable prices, neither stable production, I think. And the average growth rate was low.
    What Friedman demonstrated (If I remember well) is that the NGDP rise when money goes up, and fall when money it goes down. These up and down were much more intensive than currently.
    So, I don´t think the XIX has to do any thing with Japan today.
    what I said is if japan is not an exmaple not to follow of perfect stable prices and its consequences. The problem of fiscal debt, is not the consequences of an ultraconservative monetary policy?
    Thank for your comments.

  21. Gravatar of scott sumner scott sumner
    1. August 2010 at 06:04

    Thanks marcus, I have a new post on it.

    Ram, You said;

    “I didn’t mean to imply that expectations trap models ignore motivations, I just think that the motivations they stipulate are plausible — i.e., deflation is a very bad thing and ought to be stopped. If you don’t suppose a trap, you have to posit some other motivations, which means that central bankers in your story have to be OK with something that is pretty clearly not OK.”

    I don’t agree. Most western economists think Japan should shoot for 2% inflation. Their actual announced target is 0% inflation. So they are clearly not doing what conventional opinion says they should do. I’m hardly the only one who scratches their head over the BOJ. At one time or another it seems almost every American new Keynesian questioned why they were acting that way. The expectation trap theory cannot explain why the BOJ doesn’t aim for 2% inflation.

    You said;

    “I’m aware of the statements of Bernanke and others that there’s more they can do, but they’re not going to do it unless things get worse. One possible explanation is that, in fact, there is little more that they can do but they want to quash deflationary expectations by saying that they have the tools to prevent it and they will use them if necessary. This is consistent with the trap story, whether or not it’s true.”

    Here’s my response:

    1. There are clearly things they can do.
    2. They say there are things they can do.

    I go for the most straightforward explanation of those two facts. Even Krugman admits there are things they can do, like higher inflation targets and more QE. They haven’t done them yet.

    You asked:

    “If your view is that only you (or you and a few others) are sticking up for the textbooks, then the problem generalizes: why are not only central bankers, but also economists in general, ignoring the stuff they teach to grad students? It’s fair enough to say that it has happened before, but that doesn’t explain why it happens.”

    This is a genuinely difficult question, which I’ve speculated about at great length. The best I can do is the following:

    1. A few Fed official are old-style Keynesians, who don’t think more can be done (Yellen)

    2. Most favor a higher level of AD.

    3. A sizable minority (mostly regional presidents) prefer lower than 2% inflation, and follow the “opportunistic disinflation” theory.

    4. Bernanke likes consensus, doesn’t like votes where 3 or 4 FOMC members dissent.

    Other explanations are possible, but this is the best I can do. BTW, I’d guess Krugman has a similar view, if pressed on the issue.

    Regarding your last paragraph, I can see you are pretty knowledgable and open-minded. For what it’s worth, I have an unconventional view of monetary policy that most people overrate the importance of interest rates as an indicator of the stance of monetary policy. My hunch is that there is no single explanation silver bullet for what went wrong. How about the following.

    1. The Fed wrongly thinks policy is already highly expansionary, ignoring the IOR and the fact that low rates often reflect a weak economy, not easy money.

    2. The Fed prefers to err on the side of low inflation rather than overshooting.

    3. The Fed worries too much about inflationary “time bombs” in an era with real-time inflation expectations in TIPS markets.

    Put it all together and you have a mixture or bad models and excessively conservative objectives, no one of which can explain the failure, but in combination they can. Does that make any sense?

    Bob, Thanks. Al I would add is that because the economy fell so sharply below the 5% trendline in 2009, a bit faster growth is acceptable during a catchup. Once we’ve caught up (at least partially), I’d be fine with even 4% NGDP growth over time.

    Jim, It didn’t. Japan has declining population and weak productivity growth in its huge domestic sector. The Japanese situation combines three genuine recessions (some time in the 1990s, 2001 and 2009, with slow trend RGDP growth. So it seems like one long recession, but there are actually 3 cycles there.

    There is also the problem of downward wage stickiness. When the US had trend deflation in the late 1800s, our NGDP still rose. In Japan the NGDP is back to 1993 levels, lower per capita (the population only started declining recently.) So if workers don’t accept lower wages, you get unemployment.

    Richard, It hasn’t really been growing since 1993, but there have been mild cycles, nothing dramatic except the slowdown after 1990.

    Luis, Price stability would work better in a country like China, because you could still have 10% per year NGDP growth. I should also explain to people that although the Japanese headline CPI has been stable, the GDP deflator has been falling about 1% per year. I suppose imported oil prices explain some of the difference, sales taxes as well.

    Doc Merlin, I hope the Fed isn’t trying to stabilize the dollar now. Late 2008 would have been a better time, when it was rising.

  22. Gravatar of Left Outside Left Outside
    1. August 2010 at 11:53

    As you always say, expectations are just as important as actions.

    Martin Wolf once suggested that all Japan has to do is hire an Argentinian for their Central Bank and inflation will almost instantly shoot up.

  23. Gravatar of scott sumner scott sumner
    2. August 2010 at 05:01

    Left Outside, How about a dozen Zimbabweans?

  24. Gravatar of Morgan Warstler Morgan Warstler
    2. August 2010 at 07:07

    @Ram,

    The real answer to your last question is that the Fed is run for and by bankers.

    That’s actually interesting Scott, do you disagree with this basic fact? If so, why?

  25. Gravatar of Doug Bates Doug Bates
    2. August 2010 at 07:42

    I think the argument that Japan is a nation of old savers, and therefore wants 0% inflation in the home currency, is probably the correct one. I don’t know anything about how the board of the BOJ is selected, but you’d think that if the country were really aching for higher inflation, somebody would’ve appointed the right kind of members to the board. Old savers want their money back more than they want a booming economy.

    As for why our own Fed isn’t doing as much as it could, I would at least consider a Republican partisan bias among the current board members — not counting the three new Obama nominees who are planning to join them. I don’t mean that they are purposely engineering a double dip just to kick out Obama, but that they might be more willing to take pro-growth pro-inflation risks if they had a president belonging to their own party. Isn’t it human nature to take more risks to help somebody you like, compared to somebody you don’t like? And in our own country, we also have a large number of old savers approaching retirement — perhaps they, and their elected representatives, would rather risk future growth than risk the value of retiree savings.

  26. Gravatar of woupiestek woupiestek
    2. August 2010 at 12:39

    What’s so magical about 2% inflation; why is it better than 0 or 5% for example? I think I understand the claim about the stability of the monetary base: people try to avoid the inflation tax and minimize their cash holdings. Then again, does 2% really matter that much?

    Could central banks target a constant level of NGDP or would that destroy the economy?

  27. Gravatar of If It’s Good for the Goose… «  Modeled Behavior If It’s Good for the Goose… «  Modeled Behavior
    2. August 2010 at 13:48

    [...] the BoJ’s previous behavior is being mimicked by the Federal Reserve. Both central banks have made a choice, no long-run* “trap” involved. *Using “long-run” to indicate “after [...]

  28. Gravatar of scott sumner scott sumner
    3. August 2010 at 05:34

    Morgan, If they are trying to help bankers, they aren’t doing a good job. Banks have lost a ton of money, even with the bailouts.

    Doug, Your view of GOP bias doesn’t explain the policy of late 2008, which badly hurt McCain.

    woupiestek, One of my posts with Selgin in the title discusses zero NGDP growth. You can google it. It is a very complicated issue, but there are problems associated with liquidity traps and sticky wages.

  29. Gravatar of TheMoneyIllusion » Will those &%$#@& ever learn? TheMoneyIllusion » Will those &%$#@& ever learn?
    4. May 2012 at 07:44

    [...] In 2006 the BOJ raised rates and cut the monetary base by 20% despite no inflation, completely demolishing what was left of Krugman’s expectations trap argument for Japanese deflation.  Later the BOJ [...]

Leave a Reply