My slow response to Tyler Cowen’s quick response
Tyler Cowen reacted to the recent Fed decision. I don’t understand several of his cultural references, but I’ll respond to at least some of his points:
I would put it thus: the Fed probably decided to do the best it could within political constraints and a framework of more or less stable prices. Which won’t do much good at all.
They are certainly operating under political constraints, and what they’ve done last week certainly won’t help. But I also think they’ve shown a lack of creativity. In some ways their actions (QE and Twist) seem more radical that 2% inflation targeting, level targeting. But the latter policy would actually be far more expansionary. Both NGDP and RGDP would have to grow considerably faster than currently expected to get inflation up to 2% over the next 5 years (especially using the Cleveland Fed measure of expectations.) Admittedly, even that policy would result in a sub-par recovery. But how radical is it? It would essentially mean the Fed is reneging on the employment mandate, and targeting prices only. And we now live in a world where even that sort of conservative dream policy is viewed as being too stimulative.
1. The median voter hates price inflation. Don’t blame Bernanke.
The median voter doesn’t understand inflation. They don’t know the difference between supply-side inflation and inflation. So it’s no surprise that “inflation” is unpopular. Bernanke would be creating demand-side inflation, which raises the real incomes of Americans. It’s an open question as to how unpopular that would be. There’s no question that QE2 wasn’t all that popular. But I’d make two points. Obama was significantly more popular when QE2 was creating 200,000 jobs a month and reducing the unemployment rate, than he is now, with oil prices falling fast. Second, part of the oil price increase under QE2 was Libya, which isn’t demand-side at all.
2. Today price inflation will accelerate real wage erosion, or at least is perceived so, who wants to take credit for that?
Demand-side inflation reduces real hourly wages (sometimes) but raises real annual incomes. People care much more about real annual incomes than real hourly wages. They want to work. A president would much prefer real hourly wages falling and real incomes rising, rather than the reverse.
3. Core CPI is already going up at a rate of two percent and 3.8 percent for the broader bundle, at least for the time being. Voters don’t know or care what is embedded in the TIPS spread, etc.
Lots of presidents have been highly popular with 2% core and 3.8% headline inflation. Those are very typical inflation rates. Not many have been popular with 9% unemployment for as far as the eye can see. Voters do care about headline inflation, but it’s only averaged 1% over the past three years, and is expected to average about 1.4% over the next 5 years. Headline inflation isn’t the biggest economic problem in America, unemployment is. That’s why Obama is highly unpopular. Plummeting house prices mean lower “inflation.” Do a poll and find out how many voters see “inflation” that way; see how many actually welcome lower housing “inflation.” For most voters inflation is the price of gas, period.
4. Some of the “inflationists” ignored supply-side factors and bottlenecks and didn’t see this price pressure coming. That has thrown their entire analysis into doubt, unjustly probably but nonetheless. In any case it is no longer the simple story where Q goes up first and only later does P rise.
I strongly agree here. I’ve always argued that AD raises prices—there is no such thing as a flat SRAS. And it does so right away, due to commodity prices. The peak oil problem makes this even worse, as Tyler indicates. The rising inflation is an embarrassment to demand-siders who have focused their analysis on the need for higher inflation and who buy into Keynes’s “bottleneck” theory of inflation, or NAIRU models. FDR disproved those models when he generated rapid inflation in 1933. On the other hand NGDP growth has been slowing from an already low level, so us market monetarists are seeing our predictions vindicated. If you don’t generate robust NGDP growth, you CANNOT get a robust recovery.
Every now and then, you ought to conclude that what you see is what you get and that is because of the rules of the game. When it comes to further monetary stimulus, I’m not sure there’s so much more to say.
Maybe not right now, but this policy will eventually fail. And when it does we’ll be right back here debating the need for more monetary stimulus. Eventually the Fed will do what it should have done in 2008-09, but after much needless suffering. Just as eventually (in 1981) the Fed did the tight money policy it should have done in 1966. And eventually (in 1933) it did the easy money policy it should have done in 1930. That’s why pundits need to keep up the pressure, no matter how much it looks like we are losing.
PS. At the request of some commenters, I added a link to my new NGDP paper on the right side of this blog, in the category “Quick intro to my views.” I think it is the best place to see my policy views in one place.