In a recent post, James Hamilton argues that even if a stimulus package were to substantially boost nominal spending, the paralysis in our financial system would prevent an increase in real output, and we would instead end up with stagflation.  I do think there is a grain of truth in this argument, and more than a grain if considering fiscal projects that call for resources to be quickly reallocated.  Hamilton may be too pessimistic about the potential of monetary policy, however.  (Interestingly, we end up with similar views on stimulus policy–(3% inflation targeting in his case), but I am more optimistic about what that can achieve.   Here’s two reasons why:

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I have spent the past 6 days feverishly creating 15 posts, so now it’s time for a break. Because I have only now begun to publicize the blog, most of you have probably just arrived. The “About the blog” post provides the motivation for the sustained assault on recent Fed policy that follows. Now that I have got some (but not all) of my pent-up criticism off my chest, I hope to gradually become more like a normal blog, commenting on current events and other blogs. Here are some coming attractions:
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Lots of economists pay lip service to rational expectations, but don’t really believe it in their bones. By that I mean they use it in their theoretical models and then casually analyze real world problems using the old, pre-Ratex, Keynesian model. Here’s an example of why rational expectations are so important.

 
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I only met Bernanke once, when he presented a seminar at Bentley on his 1983 paper claiming that that disintermediation played a big role in the Great Depression, independent of the contractionary monetary policy.  I asked just one question:  “What impact would the banking problems have had if the Fed had successfully targeted nominal GDP growth?”  It was many years ago, and I don’t recall his precise answer, but I am fairly certain that he hesitated, and then said something to the effect that the bank failures would still have had an impact on output, but that impact would be somewhat lessened.

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In an earlier post I discussed my favorite monetary policy regime, under which the Fed buys and sells unlimited CPI or nominal GDP futures contracts at a price equal to the policy goal.  There is actually a fairly large literature on this idea, including people like Kevin Dowd, Bill Woolsey, David Glasner, and (my coauther) Aaron Jackson.  Slightly different approaches were taken by Robert Hall and Robert Hetzel.  At one time I thought that I had discovered the concept back in 1986, but I later learned that Earl Thompson had already mentioned the idea, but never published it.

Because it’s such an unusual way of thinking about monetary policy, it might help to compare it to the gold standard.  The U.S. successfully pegged the price of gold at $20.67/oz. from 1879-1933, and at $35/oz, from 1934 to 1968.  So in a technical sense a gold standard is very doable, even the devaluation of 1933-34 was not done because we ran out of gold, but rather to further FDR’s macro objectives.  But that is also exactly what is wrong with a gold standard, pegging the nominal price of gold does not stabilize the relative price of gold (in terms of other goods.)

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