A slightly off-center perspective on monetary problems.
People that develop new ways of looking at the world are most successful if they can create a new language, a new set of metaphors. I don’t have the literary skills of a Keynes or a Freud, but then again I also don’t have such grandiose theoretical objectives.
Den ganzen Beitrag lesen…
This has been a very busy week. But I’m not complaining, as I got what I wanted—lots more people paying attention to my views. I’d like to correct one thing I said in my previous post, it is not true that Earl Thompson has given up on macro. He has done quite a bit of work that I was not aware of, and you can link to many of his papers by going to his website. He has some very unconventional views that combine monetary policy, fiscal policy, and politics into an overarching model.
My previous post was my final attempt to sell my view of the crisis. In the future I will spend more time responding to commenter requests, discussing current events, and other miscellaneous topics. One request was for more graphs, which might buttress my argument. Hence today’s post. Soon I hope to respond to a request for a post on 1932, and then a request for something on monetary policy options in other countries.
Right after this I will post a long piece on monetary policy. Because I am still not well, I will take a brief break before starting to address yesterday’s comments. But I thought it might be helpful to clarify a few points that have been raised in several comments:
1. I am not an inflationist. If the Fed policy is 2% inflation, I favor they continue with business as usual, not adopt some sort of inflationary bailout of foolish debtors. If debts were made on expectations of 2% inflation, the Fed shouldn’t suddenly change its policy to 0% inflation. If they later decide a lower rate is better, don’t make the policy shift in the midst of the worst credit crisis in world history.
Actually I think their “dual mandate” means that they implicitly favor something closer to a 4.5% or 5.0% nominal GDP growth target. If so, they should continue on with that target, business as usual.
2. I am not much interested in the various sectors of the economy. I understand that the housing sector has declined sharply between mid-2006 and mid-2008, but except for a tiny drop in late 2007, real GDP rose continuously. Yes growth slowed in the first half of 2008, but I don’t know whether that was due to the real estate decline or the oil shock. So if commenters tell me that he “real problem” is housing, or banks, or some other sector, I will only believe you if you can show me that it would somehow prevent the Fed from boosting nominal GDP at 5% a year. That’s not to say that these things don’t matter, I can envision these sectoral shocks impacting productivity, and thus turning 5% nominal growth into a bit less real growth and a bit more inflation than we’d like, but there’s nothing we can do about that (from either monetary or demand-side fiscal policy.) And I think with 5% nominal growth we’d find that the “productivity shock” is much less than most people envision–partly because 5% nominal growth, even that sort of expected nominal growth, would immediately improve the banking system’s balance sheets.
3. I understand why people might find my causality thesis confusing. I claim tight money caused the late 2008 crisis, but my specifics seem to point to financial stress triggering an increase in money demand. There is precedence for this sort of “policy errors of omission” view of causality–Friedman and Schwartz used it for 1929-32 (although Krugman doesn’t buy it.) But I think it is especially appropriate for the modern Svenssonian view of monetary policy targeting the forecast, which the Fed seemed to be following in 1982-2007. (And Bernanke even hinted that they were following this approach.)
Acknowledgements
I’d like to thank Bill Woolsey for helping me out in the comments section. Bill and I both worked on unconventional monetary systems in the early 1990s, and he probably knows my thinking as well as anyone. He read this blog from the beginning. My colleague Aaron Jackson has also been very helpful. And while I am thanking people, I’d like to thank my wife and daughter for supporting me during the long and frustrating period when no one was paying any attention to my policy views (and when my Depression manuscript was rejected by CUP.) I’d also like to thank my sister Carol and colleague Swati Mukerjee for strongly encouraging me to go public with my policy views. (And my other colleagues.) And also my former student Tianning Yu, for suggesting that I start a blog to publicize my views.
I’ve already argued that the current depression was caused by an excessively tight monetary policy. But why did policymakers get it so wrong? I don’t think it’s just the Fed, there is a deeper problem in way the profession as a whole approaches these issues.
We all know what tight money means, don’t we? Some of us lived through the double-digit interest rates of 1979-81. But what does it really mean? What is the tightest money imaginable?
It seems obvious that the tightest conceivable monetary policy would cause deflation, or at least let’s say expectations of future deflation (as prices are sticky.) So that rules out 1979-81. One percent deflation is pretty tight, but why not try for 5% or 10%? Beyond some point you run into a problem–the real return from holding cash would rise to implausible levels. Perhaps with severe expected deflation price stickiness would evaporate from the sort of goods that are easily arbitraged. So let’s just stop with a policy tight enough to generate 3% expected deflation.
