About

Welcome to a new blog on the endlessly perplexing problem of monetary policy. You’ll quickly notice that I am not a natural blogger, yet I feel compelled by recent events to give it a shot. By “recent events” I don’t mean the financial crisis, but rather the dramatic fall in aggregate demand since last summer. Indeed, one goal of this blog is to show that we have fundamentally misdiagnosed the nature of the recession, attributing to the banking crisis what is actually a failure of monetary policy. The intended audience is professional economists as well as others with a strong interest and background in macroeconomics. I have spent 25 years researching the Great Depression, liquidity traps, and forward-looking monetary policy (especially policies that utilize market forecasts.) Last October I noticed that the Fed (and other central banks) had lost credibility, allowing market expectations for growth and inflation to fall far below their implicit target. In other words, the severe economic slump seemed to be caused by tight money–not tight in any absolute sense (more on that later), but relative to what was needed to meet the Fed’s objectives. To my great frustration, I found few if any macroeconomists who saw things that way, even though it seemed a logical implication of mainstream macro theory. A blog is not the place for a lengthy dissertation, and so here I’ll merely list three views that underlie my unusual take on the current recession: Premise 1: The only coherent way of characterizing monetary policy as being either too“easy” or “tight” is relative to the policy stance expected to achieve the central bank’s goals. Premise 2: “Monetary policy can be highly effective in reviving a weak economy even if short-term interest rates are already near zero.” Premise 3: After mid-2008, and especially in early October, the expected growth in the price level and nominal GDP fell increasingly far below the Fed’s implicit target. In plain English, the first premise means the Fed should adopt the policy stance most likely to achieve its goals. It is a point forcefully advocated by Lars Svensson, who Paul Krugman recently cited as an expert on the role of expectations in monetary policy. The second is a quotation from Mishkin’s best selling monetary economics text (p. 607), i.e. it’s what we have been teaching our students. And I have encountered few if any economists who disagree with my third assumption. Indeed, if this were not so, why would Bernanke be calling for fiscal expansion? The logical implication of these three premises is that the Fed has the ability to boost nominal growth expectations, and if they let those expectations fall far below target (as they did last fall) the subsequent recession (depression?) is their fault. Why does almost no one else see things that way? That’s what I’d like to explore. At the same time, I assume that a blog must be more interesting than a research paper, so I’ll circle around these issues lightly. I’d like to mix together observations on current events, commentary on other economic blogs (Krugman, Cowen, Hamilton, Mankiw, etc.) and fun facts from monetary history. I’ll have plenty to say about misconceptions about Keynes, liquidity traps, the New Deal, and other related topics which have suddenly become highly topical. Many of my best ideas will pop up early, so if you come to this blog much later, you might check the February 2009 archive. Thanks for reading. I welcome any serious comments.