In earlier research Dr. Krugman pointed out that monetary policy could be effective in a liquidity trap, as long as it was expected to be permanent.  One way of doing that is with inflation targeting (level targeting.)  The Fed should commit to a rising price level path, which could lead to lower real interest rates and higher AD.  Dr. Krugman recently argued that the Fed is too conservative to adopt such a policy today, and things would have to get worse for them to do so.  Of course Ben Bernanke is a student of the Great Depression, and obviously wouldn’t let things get too much worse.  Indeed the so-called “QE policy” instituted in March of this year was a tacit admission by the Fed that things had gotten worse, and that more aggressive steps were necessary.  Since then the outlook has become a tiny bit better, although it’s hard to say exactly why.  (In my view it’s 80% China, 15% QE, and 5% fiscal stimulus.)

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Before I begin I’d like to thank Dilip, who sends me many useful articles, and Scott (aka “Lawton”) who recommended that I set up the “FAQs” link.  It already got a nice review from Bryan Caplan, so I think it was an excellent idea.  I plan to improve it when I have a bit more time.  BTW, that language snob Bob Murphy insisted “Frequently Asked Questions” should be “FAQ.”  He doesn’t realize that not only are there lots of questions, but they are asked over and over again by newcomers.  So the double plural is required.

No one commented on my pathetic attempt to channel Lovecraft in the final paragraph of my “Mind Snatchers” post.  I’ve always been fascinated by Lovecraft, despite his schlocky writing style.  Especially his collection of letters, which depict a life that mine is increasingly resembling.

[BTW, Michel Houellebecq insists Lovecraft is a superb stylist.  Yes, he’s French, but he makes an interesting argument.]

Speaking of Lovecraft’s style, I am afraid my Austrian readers may find this essay to be an unspeakable horror.  But if you find yourself muttering “Sumner can be provocative, but this time he’s gone too far,” remember that new insights can often come out of very far-fetched thought experiments.

In my Snatchers post I linked to an interesting piece by Leigh Caldwell.  He discussed a speech where New York Fed president Dudley recommended that the Fed try to prevent asset bubbles.  I was once offered a job at the NY Fed, and so I tried to picture myself working in the economics research unit.  I can just imagine us getting a memo from the Fed president, instructing us to figure out when stock prices are inflated, and then recommend corrective action.

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At this point my indebtedness to GMU’s economics department is only slightly below the fast rising national debt.  You have probably seen some very kind comments from Tyler and Bryan, and there have been some behind the scenes favors as well.  I have a persistent feeling of guilt that I am not able to reciprocate.  Thus I was horrified to recently discover that I had not even answered a question posed by Bryan a few months ago.  He had asked whether investor panic might have been an independent shock hitting the markets last October.  I responded, but never saw his follow-up:

In the comments, Scott graciously replied:

“As long as you define “panic” as “correctly ascertaining that the monetary authority was about to embark on a dramatically lower NGDP growth trajectory that would plunge the world into depression” then I am completely with you.”

I’m afraid I’ve got more in mind.  Why can’t we think of the public’s mood as an independent – and highly volatile – causal variable?

I didn’t expect a panic in October, 2008.  But when it happened, it sure didn’t seem to be due to news about nominal GDP.  It seemed to be due to news about the public’s mood.  A week before, the natives were calm.  Then they suddenly got amazingly restless.

As long as this restlessness is unpredictable, it’s perfectly consistent with EMH.  So this account seems to meet Scott’s objections to distant “root cause” theories.  And it seems to fit our experience of actually living through those days, doesn’t it?  So what’s wrong with blaming an exogenous panic attack?

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Wars make people think and do stupid things.  So does deflation caused by tight money.  The intellectual low point of 20th century macro occurred in 1938, when a promising recovery in 1936 turned into renewed depression and deflation.  Interest rates fell to zero, feeding the view that money was irrelevant.  A 1938 EJ article by Joan Robinson provides a good example of the zeitgeist.  Here she criticizes Bresciani-Turroni’s argument that the German hyperinflation was caused by their government printing too much money:

“An increase in the quantity of money no doubt has a tendency to raise prices, for it leads to a reduction in the rate of interest, which stimulates investment and discourages saving, and so leads to an increase in activity.  But there is no evidence whatever that events in Germany followed this sequence.”

So easy money couldn’t possibly have caused the German hyperinflation because German interest rates were not very low.  And everyone knows that easy money is associated with low interest rates.  I won’t insult the intelligence of my readers by explaining what is wrong with her reasoning.

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I just added a FAQ section on the right side of the blog.  But I don’t plan to answer comments over there.

Today I’ll start with a very brief bio of four uber-important economists who were together at Princeton back around the turn of the century.   Since I can’t go five minutes without talking about myself, I’ll add a brief explanation of how their work relates to mine.  Then I’ll use their careers to speculate about what an ideal FOMC would look like.  Keep in mind I don’t know any of these people, and thus the portraits will be very sketchy.

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