Williamson on NeoFisherism (define “loosening”)
Stephen Williamson has a new post that interprets recent monetary history from a NeoFisherian perspective. It concludes as follows:
What are we to conclude? Central banks are not forced to adopt ZIRP, or NIRP (negative interest rate policy). ZIRP and NIRP are choices. And, after 20 years of Japanese experience with ZIRP, and/or familiarity with standard monetary models, we should not be surprised when ZIRP produces low inflation. We should also not be surprised that NIRP produces even lower inflation. Further, experience with QE should make us question whether large scale asset purchases, given ZIRP or NIRP, will produce higher inflation. The world’s central bankers may eventually try all other possible options and be left with only two: (i) Embrace ZIRP, but recognize that this means a decrease in the inflation target – zero might be about right; (ii) Come to terms with the possibility that the Phillips curve will never re-assert itself, and there is no way to achieve a 2% inflation target other than having a nominal interest rate target well above zero, on average. To get there from here may require “tightening” in the face of low inflation.
I partly agree, but disagree on some pretty important specifics. I thought it might be instructive to start out by rewriting this paragraph to express my own view, with as few changes as possible (in bold):
What are we to conclude? Central banks are not forced to adopt ZIRP, or NIRP (negative interest rate policy). ZIRP and NIRP are choices. And, after 20 years of Japanese experience with ZIRP, and/or familiarity with standard monetary models, we should not be surprised when ZIRP results from low inflation. We should also not be surprised that NIRP results from even lower inflation. Further, experience with QE and inflation forecasts embedded in TIPS should not make us question whether large scale asset purchases, given ZIRP or NIRP, will produce higher inflation. The world’s central bankers may eventually try all other possible options and be left with only two: (i) Embrace ZIRP, but recognize that this means a decrease in the inflation target – zero might be about right; (ii) Come to terms with the possibility that the Phillips curve will never re-assert itself, and there is no way to achieve a 2% inflation target other than eventually having a nominal interest rate target well above zero, on average. To get there from here may require “loosening” in the face of low inflation.
Why do we reach such differing conclusions? I think it’s because I have a different understanding of recent empirical data. For instance, Williamson’s skepticism about monetary stimulus in Japan is partly based on his assumption that the recent sales tax increase raised the Japanese price level by 3%. But there’s never a one for one pass through, as it doesn’t cover major parts of the cost of living, such as rents. So the Japanese price level (net of taxes) has risen by considerably more than Williamson assumes (albeit still less than 2%/year). Even more importantly, Japan had persistent deflation prior to Abenomics. And if Williamson is going to point to special factors such as the sales tax rise, it’s also worth mentioning that his recent data for Japan (and the other countries he considers) is distorted by a large one-time fall in oil prices. Almost all economic forecasters (and the TIPS markets) expect inflation to soon rise from the near zero levels over the past 12 months. Abenomics drove the yen from 80 to 120 to the dollar—-is that not inflationary?
In the Swiss case Williamson mentions low rates and asset purchases, but completely misses the elephant in the room, the huge upward revaluation of the franc earlier this year, which was widely condemned by economists (and even by many Swiss). This policy was unexpected, unneeded and undesirable. It immediately led forecasters to downgrade their forecasts for Swiss inflation, and those bearish forecasts have turned out to be correct. I hope that’s not the sort of “tightening” of monetary policy that Williamson believes will lead us to higher inflation rates.
Seriously, I’m confident that Williamson would agree with the conventional view that currency appreciation is deflationary. That should send out warning signals that terms like “loosening” are very tricky. Before we use those terms, we need to be very clear what we mean. You can achieve higher interest rates through either loosening (a crawling peg devaluation forex regime) or tightening (open market sale of bonds), it all depends how you do it. More specifically, it depends on the broader policy context, including changes in expectations of the future path of policy.
I think he also gets the Swedish case backwards. The Swedish Riksbank tried to raise interest rates in 2011. Instead of producing the expected NeoFisherian result, it led to what conventional Keynesians and New Keynesians and Market Monetarists would have expected—falling inflation. It led to exactly the type of bad outcome that Lars Svensson predicted. So Svensson was right. And contrary to Williamson, the Riksbank did not turn around and adopt Svensson’s preferred policy, which is actually the “target the forecast” approach; rather they continued to reject that approach. They continued to set rates at a high enough level so that their own internal forecasts were of failure. Once a tight money policy drives NGDP growth lower, the Wicksellian equilibrium rate falls and policy actually tightens unless the policy rate falls as fast or faster. That did not occur in Sweden.
Let me try to end on a positive note. I have a new post at Econlog that took a position roughly half way between the NeoFisherians and the Keynesians. Brad DeLong had noted that Friedman often claimed that low rates are a sign that money has been tight. I’d emphasize, “has been.” Krugman said this was wrong, at least over the time frame contemplated by Friedman. I disagreed, defending Friedman. I believe that Keynesians overestimate the importance and durability of the so-called “liquidity effect” and underestimate how quickly the income and Fisher effects kick in. At the same time, as far as I can see the NeoFisherians either ignore the liquidity effect, or misinterpret what it means. (My confusion here depends on how literally we are to take the “tightening” claim in the quote above.)
Question for the NeoFisherians:
I often discuss the Fed announcements of January 2001, September 2007 and December 2007. That’s because all three were big shocks to the market. In all three cases long-term interest rates immediately reacted exactly as Irving Fisher or Milton Friedman might have expected. In the first two cases, easier than expected policy made long-term rates (and TIPS spreads) rise. And in the last case tighter than expected policy made long-term rates (and TIPS spreads) fall. Please explain.
To me, that’s the Fisher effect. But here’s the problem, the Fed produced those three results using the conventional manipulation of short-term rates. Thus in the first two cases the Fed funds rate was cut more than expected, and vice versa in the third case. From a Keynesian perspective this is really confusing—why did long-term rates move in the “wrong way”? From the NeoFisherian perspective this is also really confusing—why did moving short-term rates one way, cause TIPS spreads (and long term rates) to move the other direction? From a market monetarist perspective this all makes perfect sense. (It doesn’t always play out this way, but if you look at the really big monetary shocks the liquidity effect is often swamped by the long-term effects.)
HT: Marcus Nunes