He’s Baaack (to his 1990s views)

Japan has experienced near continuous deflation in its GDP deflator since 1994, averaging about -1% per year.  As I recall there were small positive upticks around 1996 and 2008, but I believe they are back in deflation.  Paul Krugman was one of the first to address the Japanese situation, and also to understand the importance of an aggressive monetary policy.  Here is what he had to say in 1999 about fiscal stimulus in Japan:

I have been wrong about a lot of things lately. . . . Of course, Japan could surprise us all. Perhaps this time massive fiscal deficits will not only keep the economy afloat, but provide the long-awaited, never-delivered jump-start: the self-sustaining expansion in private demand that continues even as the public works programs wind down. But to believe in that jump-start you must believe in a very exotic model of the macroeconomy, one in which there are multiple equilibria and a temporary fiscal expansion can jolt the economy out of a low-level trap. Well, maybe. But isn’t it funny that the orthodox policy now being followed can be justified only by invoking highly speculative, dubious models with little empirical backing; whereas the radical, unorthodox policy I have advocated flows naturally from textbook economics?

Before getting to the meat of his argument, let’s just take a moment to savor that first line, from what now seems like a long lost golden age—the 1990s.  I wonder if there is a correlation between a person’s humility and the quality of their analysis.  (If so, I’m in big trouble—as are some commenters on this blog.)

I don’t have much to add to Krugman’s views on fiscal stimulus, except perhaps that I wish I was capable of getting to the heart of the matter so quickly.  There’s a reason the NYT picked Krugman to write for them.

But what about monetary policy, presumably that would also be ineffective, as Japan was clearly in a liquidity trap.  Here’s what Krugman said about monetary stimulus back in 1999:

Yet while the idea of monetization has finally begun to pick up some real political momentum, its opponents – both Japanese and non-Japanese – remain dead-set against it. Their arguments make amazing reading. Consider the following lines of argument, all of which may be found in a Reuter’s report from last week:

1. Monetization will lead to inflation: Because money-financed deficit spending led to uncontrollable inflation in the 1940s – in an economy that was engaged in massive military spending, and by then operating at full capacity – critics of monetization argue that it will lead to uncontrollable inflation now. Um, isn’t the current problem deflation? Isn’t this, as Ralph Hawtrey said in 1931, a case of “crying ‘Fire, fire!’ in Noah’s Flood”? (See my piece  The hangover theory )

2. Monetization will encourage the government to run ever-larger deficits: Japan’s government is now running huge deficits because it is trying to stimulate the economy with fiscal policy. Are the critics – like Jardine Fleming economist Chris Calderwood, who wants to “put a strait-jacket on Japanese fiscal policy” – saying that it should stop doing so, without any alternative way to maintain demand? Then I guess they are saying that Japan should simply accept a depression in the name of behaving responsibly. I would have thought that monetization, both because it is an alternative to fiscal policy and because a stronger economy would increase revenues, would help reduce the size of prospective government deficits – and conversely, of course, it is the dangerous size of those deficits that makes monetization now the last, best option for avoiding depression.

Thus not only might monetary stimulus have been effective, but the resulting economic growth actually allows one to avoid “huge deficits.”  It’s an “alternative to fiscal policy.”  There is nothing new in my blog; it is just warmed over 1990s Krugman.  Unfortunately, good things cannot last forever.  In recent years Krugman has become more and more of an old-style Keynesian, at least in his policy views.  But that creates an awkward problem.  Why didn’t those huge budget deficits stimulate the economy?  Perhaps because they weren’t so huge after all, indeed they were quite small.  This is from 2008:

The first took place in 1937, when Franklin Roosevelt mistakenly heeded the advice of his own era’s deficit worriers. He sharply reduced government spending, among other things cutting the Works Progress Administration in half, and also raised taxes. The result was a severe recession, and a steep fall in private investment.

The second episode took place 60 years later, in Japan. In 1996-97 the Japanese government tried to balance its budget, cutting spending and raising taxes. And again the recession that followed led to a steep fall in private investment.

I hope to update this later when I have more time.  I think the above quotation is both a bit unfair, and not unfair enough to Krugman.  I haven’t had time to dig through all of his old blog posts, but I recall that he has cited recent research showing the deficits in Japan actually weren’t all that big. Perhaps he didn’t know this in 1999.  Fair enough.  But I also recall that those studies show that fiscal stimulus was not just lacking in 1996-97, but throughout the entire deflationary period.  I mention this in case someone argues that he is only referring to 1996-97 when he denies that fiscal stimulus got a fair trial in Japan.  And if I am wrong, then why is Japan’s NGDP barely above 1993 levels?  In any case, this can be checked.  (Throw mud first, backtrack later if necessary.)

Fortunately, we can now welcome Krugman back to the club of fiscal skeptics.  A couple days ago Krugman posted a reply to Meltzer’s argument that countries that ran “enormous budget deficits” and expansionary monetary policies invariable ended up with high inflation.  What is Krugman’s counterexample?  The same one I immediately thought of—Japan.

(I don’t know how to post graphs yet, you need to check the link—it’s very short.)  Just to be clear, I am not arguing that Japan’s fiscal experiment did or did not provide a fair test of the multiplier theory.  There are all sorts of real world complications.  Perhaps it was effective enough to prevent even more severe deflation (although I have argued against that view in other posts.)  What amuses me is the way that the size of Japan’s fiscal stimulus seems to effortlessly expand and contract according to the debating points that are needed on that particular day.



21 Responses to “He’s Baaack (to his 1990s views)”

  1. Gravatar of at at
    6. May 2009 at 05:51

    here was meltzer’s response http://blog.american.com/?p=222

  2. Gravatar of David Pearson David Pearson
    6. May 2009 at 05:55


    Krugman is on (recent) record as arguing the Fed should pursue an aggressive, even “irresponsible”, monetary stimulus. Why keep arguing wit him when he already agrees? Enough already.

    You have more important things to consider. We don’t have your NGDP futures targeting scheme up and running, but we are at somewhat of a crossroads. You see, various NGDP futures stand-ins (equities, credit spreads) are beginning to forecast a significant NGDP recovery in 2010. TIPs spreads are positive as well.

    So, the question is, when does the Fed begin to withdraw reserves? Should they RAISE the interest payment on reserves now? Or eliminate as you have argued before? In a time line of fighting deflation to fighting inflation, where are we? How do you know?

    Of course, in an NGDP futures targeting regime, all those questions would be answered, right? As long as the Fed brings the NGDP futures price to target, they KNOW they are doing the right thing. But what if the equities market continues to zoom up, and TIPS spreads as well? What if the NGDP futures market does not draw a big enough, deep enough pool of speculators to create a definitive answer to the question, “how tight or easy is the Fed today?”

    At the end of the day, there is no substitute for judgment. In Scott Sumner’s judgment, should the Fed start to remove stimulus?

  3. Gravatar of Dann Ryan Dann Ryan
    6. May 2009 at 06:02

    Perhaps I have missed you addressing it in the influx of posts I’ve been reading… but Allan Meltzer’s initial claim, was “no country facing enormous budget deficits, rapid growth in the money supply and the prospect of a sustained currency devaluation as we are has ever experienced deflation.” The part of that that both you and Krugman leave out addressing, with your Japan paradigm is “sustained currency devaluation.” During this decade with Japan the Yen was appreciating. I understand that you said the Dollar has appreciated against the Euro since last year, but sustained appreciation that does not make. Of course Japan was the first example that came to my mind, but it does not fit the situation. Are we really to believe that Meltzer would overlook such an obvious counterpoint when making such a bold statement? The prospect of serious currency devaluation is one of the few points I find ease in getting a lot of people to agree on currently.

  4. Gravatar of ssumner ssumner
    6. May 2009 at 06:13

    David, You may not know the history of my interaction with Krugman. I asked him to support me in calling for an expansionary monetary stimulus. I said something like “I believe you have indicated it might work, but worry about the risks.” He vehemently denied ever saying such a thing, and reiterated his view that because we were in a liquidity trap monetary policy was ineffective. But that is not at all what this post was about. I wasn’t dredging up that issue.

    Yes he recently said monetary policy might be worth a shot, but he has radically changed his views on the relative importance of monetary and fiscal stimulus, as my quotations make perfectly clear. He was dubious about fiscal stimulus, and thought monetary stimulus was a good alternative. That is hardly his position today–but it is my position.

    Regarding your second question, in my view the Fed hasn’t even begun to offer any stimulus. In my view their current policy is highly contractionary. Both the Fed and private forecasters expect subpar growth, even with the fiscal expansion. And as best we can tell the markets are also very pessimistic (albeit slightly more optimistic than last month, thank God.) The TIPS spread is 0.9% for 5 years. 2% would be neutral, above 2% expansionary. We’re still contractionary. If we actually did expect decent growth (on target), and were worried about overshooting it would be ABSOLUTELY INSANE to withdraw monetary stimulus, we should withdraw fiscal stimulus. The ONLY argument for massive budget deficits was that monetary policy was stuck at 0%. If we don’t need stimulus, that’s the obvious place to cut back, EVEN FROM A KEYNESIAN PERSPECTIVE.

    Sorry for all the capital letters, you asked some really good questions, it’s just that I feel really passionate about these issues, as you can tell. BTW, the post was an attempt to be amusing, to tease Krugman a bit on his debating points. He likes to do that to others. I actually do like the 1990s Krugman quite a bit. So don’t take it as too negative.

  5. Gravatar of ssumner ssumner
    6. May 2009 at 06:30

    Dann , Good question. Yes, it is not sustained appreciation of the dollar. But is it sustained depreciation? That was my point. Meltzer obviously can’t rely on the money and deficit arguments, as they apply equally well to Japan. So it all rides on his view that the exchange rate has behaved differently.

    I think it is a judgment call as to whether Meltzer’s sweeping claim tells us anything useful about the current stance of monetary policy in the U.S. He seems to think exchange rates are highly significant (oddly for a monetarist). Well the dollar has rallied strongly against the euro in the past year, but monetary and fiscal policy have (supposedly) become dramatically more expansionary during that same 12 month period. Don’t exchange rates respond to news? So I see your point, but I still think Meltzer’s argument fell flat. In any case, although that was an important point for Krugman, it was a side issue for me. I am concerned with NGDP growth expectations in financial markets–and nobody can argue they are too high right now. (BTW, Meltzer’s term “prospect” makes no sense in asset markets that follow random walks.)

    Finally, don’t you think Meltzer would like today’s post?

  6. Gravatar of David Pearson David Pearson
    6. May 2009 at 07:13


    The Fed and the blue chip consensus are signaling a 3% real GDP growth rate a year from now. Tack on 1% of inflation and NGDP will be at 4%. Should we be using six-month forecasts instead? What level of NGDP growth would you target 12 months out? And what is “subpar” growth anyway? Does this mean you are a Keynesian? Should we steer monetary policy by the output gap? Or should we take into account that “capacity” is a nebulous concept in an economy with record imbalances, an out-sized service sector, and record leverage. If you are just another Phillips-curve enthusiast, then I am truly disappointed…we sure have enough of those.

    In any case, a few months ago one could have argued that no matter what the Fed and economists thought about the future, markets knew differently. That’s becoming less true by the day. So why are you so sure that we are “contractionary”, aside from the level of the TIPS rate, an instrument which has had an even worst record than economists in predicting inflation?

  7. Gravatar of Vijay Vijay
    6. May 2009 at 07:17


  8. Gravatar of Josh Josh
    6. May 2009 at 09:15

    Aren’t we ignoring Ricardian Equivalence? In other words, the problem isn’t whether the stimulus is big enough, but rather whether people expect that the increased spending will be permanent. I echoed Krugman (http://everydayecon.wordpress.com/2009/01/31/mcardle-stimulus-and-the-literature/) who argued using the permanent income hypothesis that a temporary stimulus program would have real effects. I still believe that he (and I) are correct on this point.

    However, a problem arises (as I have noted here: http://everydayecon.wordpress.com/2009/02/09/the-stimulus-will-fail/) when the spending is expected to be permanent. Indeed, spending on “green energy” projects and jobs initiatives are certain to be permanent fixtures of government spending for years to come. Of course, this is an addition to the lip-service of cutting spending by an amount closer to a rounding error in the budget than anything else. Thus, I have grave doubts about the efficacy of the the stimulus package and would much prefer a monetary policy solution.

    Now, we can certainly debate whether the U.S. stimulus package should be seen as a permanent increase in spending, but we can hardly have this debate over Japan. As Meltzer would say, they practically paved over the whole country using government spending and it was unsuccessful. Krugman and others (I don’t want to single him out) argue that it is because it is too small. However, I am not sure that the size matters as much as the policy design. The government expenditures certainly must have been viewed as permanent because each temporary stimulus was followed by another. Thus, under Ricardian Equivalence, the stimulus would essentially have been saved.

    I, of course, anticipate that other commenters will scoff at my reference to Ricardian Equivalence. However, while we have been very good at coming up with stories as to why it doesn’t hold the empirical evidence suggests that it does: http://www4.ncsu.edu/~jjseater/PDF/PublishedPapers/RicardianEquivalenceEBook.pdf

  9. Gravatar of ssumner ssumner
    6. May 2009 at 10:26

    David, I plan a post soon on NGDP targeting, as lots of people misunderstand the idea. The goal is not to get 5% NGDP growth a year from now (which I agree we might have), the goal is to get 5% NGDP growth OVER the next year. I don’t think anyone believes we will be even close to that number. The markets seem to expect no real growth in the final 3 quarters of 2009, as best as I can tell.

    Don’t worry, I am not just another Phillips Curve output gap Keynesian. I favor a 5% NGDP growth trajectory over time. Level targeting. What we do at the moment a new policy is adopted is debatable (one could argue for 6% in the first year and then 5% thereafter–I won’t quibble), but I certainly don’t think the Fed should pay any attention at all to real varaibles like output gaps. We had enough of that in the 1970s. Nominal targets only please.

    Regarding markets vs. economists, I have no big problem with relying on the concensus forecast of economists. What is the concensus forecast of inflation over the next 12 months right now? (Not 12 months out in the future.) I’ll bet it is not much higher than 0.9%. And last time I looked the Fed’s forecast for NGDP was also very bearish. The main problem today isn’t that the Fed cannot forecast as well as markets, they do OK, the problem is that they don’t target their forecast. But I might add that under futures targeting it is much easier to target he forecast, because there is no need to rely on discretion. And more importantly one doesn’t need to guess the policy’s credibility–this is key because credibility uncertainty creates velocity uncertainty.

    Thanks Vijay.

    Josh, You and I are among the few people who seem to “believe in” Ricardian equivilence. However, Krugman has applied it to both monetary policy and tax cut-oriented fiscal stimulus.
    In another post I argued that the whole debate over multipliers was beside the point. With optimal monetary policy the fiscal multiplier is precisely zero. What would be the relevant counterfactual for Japan if they had not had huge budget deficits? A great depression (as some Keynesians argue), or a BOJ facing pressure from Japanese industry to depreciate the yen enough to prevent a Great depression? I guess you know where I come down on that issue.
    You correctly note that Krugman argues that the Japanese stimulus was too small. But I’d use the past tense. The one and only point of the post was to show that Krugman now argues that the Japanese fiscal stimulus was “enormous.” If that is not his argument, then his attack on Meltzer is disingenuous—as he certainly implies that Meltzer is wrong in saying that no country with enormous budget deficits has ever avoided inflation. Krugman cites Japan.

    I hope this point is obvious, if not someone tell me and I’ll add an update.

  10. Gravatar of Bill Stepp Bill Stepp
    6. May 2009 at 17:32

    PK’s first statement doesn’t read like anything he’s written since then that I’m aware of, and certainly nothing in recent memory at least about the stimulis package and related events.
    Advocates of the stimulis (and other sorts of government intervention) often (usually?) take the view that whatever intervention they call for is a solution to some market failure, and that the prescribed program will usually work, unless it is short-circuited by corrupt politicians and/or greedy capitalists.
    But in the absence of government intervention (e.g., price controls, legal restrictions on banking and financial intermediation [Selgin], etc.) markets clear, unless basic economic principles are delusory. Therefore markets can’t fail at least to the extent that a clearing mechanism would eliminate malinvestments and redirect invested resources to their most highly valued uses.
    If Krugman and DeLong ever admit this elementary fact, please ring me at home even if it’s 3 AM, so that I can shout out to the household and ‘hood that we’ve won, at least on one small point. I’m willing to risk arrest for it.

  11. Gravatar of Bill Stepp Bill Stepp
    6. May 2009 at 17:48

    Scott (and Josh),

    Regarding Ricardian equivalence, there are others who accept it, Jeff Hummel for one, if I’m not mistaken. I’ve seen other favorable references to it by other commentators.
    Would it be correct to say that’s it’s a first cousin of the Efficient Markets Hypothesis/Theory? If so, then I can understand more readily why you accept it.
    I haven’t yet read the paper Josh links to but will.
    I don’t accept the EMT, at least the strong form version, but I do believe that most markets are fairly efficient most of the time. But “most” and “fairly” are slippery concepts in this context; that doesn’t work in favor of the EMT.
    Perhaps the same thing is true of RE: maybe it works most of the time, but not all of the time. (Sounding like a politician, I know.) Better to sound like one that be one!

  12. Gravatar of ssumner ssumner
    7. May 2009 at 13:10

    Thanks at, I like Meltzer, but I wasn’t too impressed by that reply. The BOJ did eventually increase the monetary base dramatically (QE) and it did not result in high inflation as Melzter seemed to suggest it should, so his whole theory seems to ride on currency depreciation, which is an odd position for a monetarist. And the dollar has rallied strongly in the past year against the euro. So why does he seem so sure that high inflation is on the way? And I’m not sure the deflation really ever ended in Japan, They’ve averaged about 1% per year deflation in their GDP deflator for 15 years, and as far as I can see, the deflation continues. So I think Japan raises some pretty serious problems for monetarists who insist that high inflation is almost inevitable.

    Bill, Yes, there is a difference of opinion between the left and the right on just how prevalent market failure really is. I guess you know my view–it’s not as a big a problem as some imagine, except in a few areas (the environment, perhaps public health, etc.) In any case, that’s not what the stimulus was about. Very little was motivated by explicit market failure arguments.

    Bill#2 I agree about the EMH. I doubt it is literally true, but the anti-EMH argument has never produced a single useful policy implication. So I still go with the EMH.

  13. Gravatar of Josh Josh
    7. May 2009 at 17:51


    I find Ricardian Equivalence very intuitively appealing. Of course, there are a great number of people who would disagree. Ultimately, however, I think that refutations of Ricardian Equivalence suffer from the same maladies as refutations of EMH (as Scott has detailed). What’s more, we have gotten quite good at coming up with reasons that Ricardian Equivalence might fail, but as the article that I linked to by John Seater details, these reasons do not seem sufficient to refute the theory empirically.

    For example (and particularly in reference to your question), one of the assumptions underlying RE is perfect capital markets. Some have suggested that if individuals are liquidity constrained (i.e. they do not have access to borrowing), we do not have perfect capital markets and therefore RE does not hold. However, it turns out that even if individuals are liquidity constrained, whether RE holds depends on why the constraint exists. If the constraint exists because of transactions costs or adverse selection, then government spending might actually perfect the market by indirectly providing the liquidity desired. However, if the constraint exists because there is uncertainty about future income, then RE continues to hold. It is probably some combination of factors, however given that RE tends to hold in empirical studies, I am inclined to believe the latter is somewhat more important. (Just ask a college student to borrow on their future earnings and see what response the bank gives them.)

    Unfortunately, I fear that a great deal of the debate regarding RE is ideological. For example, those who think that it does not hold routinely point out that it requires the assumption of perfect capital markets and they laughingly say that “of course this doesn’t exist.” However, as the discussion above suggests, it is not sufficient to say that in the absence of perfect capital markets RE will not hold because it depends on WHY we have imperfect markets. This is the problem with discussions of market failure writ large. The fact that markets fail doesn’t mean that we shouldn’t use markets or that there is a better alternative — and I am with Scott that these failures are not as widespread as some seem to think.

  14. Gravatar of ssumner ssumner
    8. May 2009 at 04:41

    Josh, I think that is a really good point. I would add that people often used to argue that perfect competition was useless, as real world markets rarely meet all the criteria. But didn’t Vernon Smith show that you get results pretty close to the prediction of perfect comp., even with some the the criteria relaxed?

    I think the key is not whether the world conforms exactly to all the assumptions in the RE model, but rather empirically whether it explains things very well. Do deficits raise interest rates? My understanding is that it is surprisingly hard to find evidence supporting the standard crowding out view of tax cuts. (This isn’t my area of expertise, so if there are now definitive studies, please let me know.)

  15. Gravatar of Josh Josh
    8. May 2009 at 09:44


    I am not aware of any recent definitive studies on the topic. Seater’s paper is now over 15 years old, but I am not aware of any influential paper that presents evidence against the results he details in his survey.

    Also, I just did some quick EconLit searches regarding RE and Japan and I was surprised to find very little.

    Lars Svennson has a working paper entitled “Monetary Policy and Japan’s Liquidity Trap”, which includes the following quotation that is relevant to both our current discussion on Ricardian Equivalance and the current economic environment:

    “Regarding fiscal policy, a fiscal expansion-an increase in the fiscal deficit-may or may not be expansionary and increase aggregate demand, depending on the composition of the fiscal expenditure, the degree of Ricardian equivalence, and so forth. Typically, Ricardian equivalence does not seem to hold, and a fiscal deficit is expansionary; however, private-sector behavior may be closer to Ricardian equivalence in a crisis situation with a perceived unsustainable fiscal and an expected immanent fiscal consolidation with increased taxes and/or reduced benefits. Japan has certainly tried an expansionary fiscal policy. This has not led to an escape from the liquidity trap, but it has certainly led to a dramatic deterioration of Japan’s public finances.”

    I am not sure why he suggests that RE does not hold. Nevertheless, this does drive home the point that I was trying to make about Japan and fiscal policy. Government spending-type stimulus quickly becomes constrained by concerns of the long-run stability of the government finance.

    He continues:

    “A money-financed rather than debt-financed fiscal expansion is often proposed as a remedy against a liquidity trap. But it is often not understood that, for a given fiscal deficit and aside from any debt-induced inflation incentives for government-controlled (rather than independent) central banks, money- or debt-financing matters through exactly the same mechanism as that discussed above in regard to expanding the money supply. Money financing of a fiscal expansion will have an effect on expectations of the future price level only to the extent that it is interpreted as a permanent expansion of the money supply.”

    Here is a link to the working paper:


  16. Gravatar of ssumner ssumner
    9. May 2009 at 04:40

    Thanks Josh, I agree with Svensson that even a helicopter drop of cash is only expansionary if expected to be permanent. And I also agree that very few people recognize this fact. In fairness, a helicopter drop is clearly much more likely to be perceived as permanent than an OMO.

    His point about expectations during an economic crisis are also very relevant to the current situation. It wouldn’t surprise me if the average Republican thinks the effects of the Obama deficits will be twice as bad as they will actually be. In that case, even if the average Democrat (optimistically) treats government bonds as 100% net wealth, RE might still fully hold for tax cuts and transfer increases (and I believe a significant chunk of the stimulus “spending” is actually disguised transfers.) And the loss of confidence could also greatly weaken the impact of actual spending projects.

  17. Gravatar of Josh Josh
    10. May 2009 at 09:40


    I actually highlighted the Svensson paper because I thought that it was a fairly solid perspective on why monetary policy isn’t impotent at the zero-bound as well as expressing skepticism about fiscal policy during a crisis. However, I have some qualms with his particular perspective:

    1. “I agree with Svensson that even a helicopter drop of cash is only expansionary if expected to be permanent.”

    I actually do not fully agree with this statement. Basically, I do not agree that permanency is a sufficient condition for the helicopter drop to have real effects. A helicopter drop would also have to be unanticipated to have real effects.

    2. I actually think that viewing QE as a helicopter drop (which I am not necessarily attributing to Svensson, but certainly there are others who do) is wrong-headed. QE that is initiated using OMO will have real effects because it upsets the portfolio balance of bank balance sheets and the net wealth of firms (what can I say, I am a credit channel guy).

    To maximize their effect, however, the central bank has to convince the public that it will continue to undertake this policy until its particular target is reached.

    3. This brings me to what the central bank should target. I am NOT on board for an inflation target. These targets leave central banks susceptible to monetary policy that is too loose in response to secular deflation. In addition, it ignores the relative price effects.

    What’s more, I think that the optimal rate of inflation is negative. I also remain unconvinced that higher rates of inflation are sufficient to generate economic growth, but that is a topic perhaps best left to a future discussion.

    I would much prefer a nominal GDP target (although I am not yet convinced by the futures target — again probably a topic for future discussion). The nominal GDP target essentially offsets changes in V with changes in M and thus avoids the exacerbating effects of the increasing demand for money.

    Thus, I think that those who favor an inflation target have stumbled upon the correct methodology for central banks (i.e. forward-looking policy and the other elements of the focus on expectations), however, I think that they have reached the wrong conclusion about the target.

  18. Gravatar of ssumner ssumner
    10. May 2009 at 14:38

    Josh, I agree with most of what you say here:

    1. I actually didn’t mean to imply “real” effects, I was only thinking expansionary in the sense of expanding NGDP. Probably poor word choice on my part. BTW, the profession has two very different concepts of monetary policy ineffectiveness; the Keynesian, which applies to NGDP, and the RBC, which applies to RGDP only. So the term is often vague. I agree with you that to have real effects it must be unanticipated (at least over some reasonable period of time.)

    2. I could see how nominal debt stickiness could imply that monetary shocks affect balance sheets in important ways. I always sort of assumed those were “suck costs” or “sunk benefits”. But the current crisis certainly shows how banking can have important effects. But “I’m still basically a sticky-wage guy” to paraphrase your remark. I still think wages are the key to unemployment, even though that’s a sort of 1920s way of looking at things. Maybe it’s because I spent a lot of time looking at the 1920s.

    3. I may eventually come around closer to your view (and those of Selgin, Woolsey, etc.) Right now I worry about downward wage rigidity and liquidity traps. If we could ever get a decent forward-looking policy regime we could dispense with the liquidity trap problem. Perhaps “money illusion” is overrated, especially in a stable money regime where workers would have to adjust to the new reality. I’ll leave that as an open question. I certainly don’t agree with crude Keynesian versions of the Phillips Curve that are based on non-rational expectations. BTW, the forward-looking policy ideas discovered by people like Svensson were discovered decades age by the so-called “new monetary economists” of the 1980s–mostly economists on the right.

    I haven’t had time to read the paper you sent, but I will. But I have read many papers by Svensson, and generally like his approach to forward-looking policy.

  19. Gravatar of In Search of Monetary Stability « The Everyday Economist In Search of Monetary Stability « The Everyday Economist
    11. May 2009 at 10:51

    […] 11, 2009 · No Comments I have been discussing a multitude of issues including quantitative easing, Ricardian Equivalence, and the current state […]

  20. Gravatar of Josh Josh
    11. May 2009 at 10:54


    I have written a lengthy post on my blog regarding my views on monetary stability, which addresses your concern about wage rigidity (albeit terse):


  21. Gravatar of ssumner ssumner
    11. May 2009 at 17:35

    Thanks Josh. That’s a good post summarizing the views of Nick, George and myself. I left a comment.

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