If the FOMC hews too closely to conventional thinking, it might be inclined to keep its target rate low. That kind of reaction would simply re-enforce the deflationary expectations and lead to many years of deflation.
Let me emphasize that I do understand that there is a problem with promising low rates as far as the eye can see. My problem with Kocherlakota is that he seems to think that the solution is tight money. At least that’s what I infer from the totality of his comments.
I’ve been so frustrated by the events of the last few weeks that I worry I am getting too negative in my posts. I’d like to maintain a high level of courtesy, like Tyler Cowen or Nick Rowe. Instead I often get too sarcastic, like . . . like those other guys.
Thus I was a bit surprised, but also heartened, to read this comment from my favorite monetary blogger (and cattle herder), Nick Rowe:
That speech by Narayana Kocherlakota is really disturbing. This guy is a top macroeconomist, and he totally f***s it up. I mean totally. It wasn’t just misspeaking, because he is quite clear the second time he makes the mistake. If the natural rate of interest rises exogenously, and the Fed doesn’t raise the nominal rate in response, the result will be….DEflation! And he’s a Fed President (so presumably this guy has some sort of power over monetary policy?).
You guys in the US are so scr***d. (And maybe we up here are too, since you are so big, even though we’ve got flexible exchange rates).
He went straight from a math undergrad into a PhD. I bet that’s the problem. He missed Intro Economics. (And he has the nerve to cr*p on Intro Economics too).
If even mild-mannered Nick Rowe is this upset, then you can imagine how a hot-head like me feels.
And then there is the financial press. Here is something Marcus sent me from the Wall Street Journal:
So what’s the problem? Here it is best to depart from monetarist terminology, with its heavy emphasis on the magical powers of the central bank. Those magical powers are highly overrated, as almost anyone who has ever run a central bank will likely tell you. The Fed can flood the banks with liquidity in an effort to stimulate economic growth (if it is willing to run the very serious risk of inflation). But that will not necessarily stimulate a demand for this money.
Correct me if I am wrong, but if the Fed is trying to boost AD, isn’t an increase in the demand for money the last thing they’d want? More and more I just scratch my head at what I read. From the same article:
But deflation and inflation predictions could both be right in a sense, if you aren’t too fussy about strict definitions. In the late 1970s, the last time Americans suffered from manic interventionism from Washington, we had “stagflation,” a combination of minimal economic growth and double-digit inflation. It wasn’t pretty.
Which year in the 1970s did we have deflation? And this:
Since deflation, in simple monetarist terms, means too little money chasing too many goods, with a consequent fall in prices, the remedy should be easy. Can’t the Federal Reserve create as much money as it wants with just a few key strokes? Well, there are some things money can’t buy. In political circumstances like today’s, one of them is public confidence.
You need “confidence” to create inflation? How much confidence did people have in Jimmy Carter? How about the Zimbabwe central bank? I had thought inflation was more likely to result from a lack of confidence. I thought you got inflation by “committing to be irresponsible.”
Both of the guys I quoted are very smart–Kocherlakota is obviously far brighter than I am. I probably agree with them both on most issues. But money is a specialized field and I just don’t have much confidence that our decision-makers or the media people who shape the discussion are on top of this issue. We need people who are “fussy” about definitions. Who understand why monetary policy does seem like “magic” to the uninitiated. Every single FOMC voter should have not only a PhD in economics but 20 years of research on monetary policy, monetary theory, and monetary history. Not one, not two, all three areas. It’s that important. (For instance, does Kocherlakota know that the Fed tried Rajan’s exact proposal in 1931, they raised rates by 200 basis points when the economy was weak and rates were very low?)
Update: I just noticed that Nick has a post with a lot of interesting discusssion. I can see I’ll have to address this issue again tomorrow.