Janet Yellen: Keynesianism costs jobs
No, she didn’t quite say that, nor does she quite believe that. But . . . well you’ll see. Janet Yellen recently gave a very interesting speech on monetary policy:
Importantly, resource utilization rates have been so low since late 2008 that a variety of simple rules have been calling for a federal funds rate substantially below zero, which of course is not possible. Consequently, the actual setting of the target funds rate has been persistently tighter than such rules would have recommended. The FOMC’s unconventional policy actions–including our large-scale asset purchase programs–have surely helped fill this “policy gap” but, in my judgment, have not entirely compensated for the zero-bound constraint on conventional policy. In effect, there has been a significant shortfall in the overall amount of monetary policy stimulus since early 2009 relative to the prescriptions of the simple rules that I’ve described.
David Beckworth pointed to one obvious implication:
What Yellen and Bernanke both need to embrace is a NGDP level target. This approach would allow the Fed to make up the cumulative shortfall created by the Fed’s passive tightening while at the same time keeping long-term inflation expectations anchored.
Interestingly, in the very next paragraph (after the one quoted by David), Janet Yellen hints that there are people at the Fed who see the logic of level targeting:
Analysis by some of my Federal Reserve colleagues suggests that monetary policy can produce better economic outcomes if it commits to making up for at least some portion of the cumulative shortfall created by the zero lower bound–namely, by maintaining a highly accommodative monetary policy for longer than a simple rule would otherwise prescribe. This consideration is one important reason that the optimal control simulation generates a more accommodative path than the Taylor (1999) rule.
That’s exactly my view. At this late date it would be appropriate to make up for only a portion of the policy shortfall since 2008. Yellen continues:
Risk-management considerations strengthen the case for maintaining a highly accommodative policy stance longer than might otherwise be considered appropriate. In particular, the FOMC has considerable latitude to withdraw policy accommodation if the economic recovery were to proceed much faster than expected or if inflation were to come in higher. In contrast, if the recovery faltered or inflation drifted down, the Committee could provide additional stimulus using its unconventional tools, but doing so involves costs and risks. Given the unprecedented nature of the current economic situation and the limits placed on conventional policy by the zero lower bound on interest rates, these issues of risk management take on special importance.
These three paragraphs form a devastating critique of Keynesian monetary policy. Keynesians have lots of arguments for using interest rates as a policy tool (or instrument, or target, depending on your perspective) but none of them hold much water. Yellen is basically admitting that the Fed is allowing hundreds of thousands of workers to remain unemployed because the Fed’s preferred policy tool is stuck at zero. And they don’t like unconventional tools (which contrary to her assertion are not “risky.”)
The Fed really needs to move away from using any policy rules with a zero bound. Some non-zero bound tools include Bennett McCallum’s policy rule for adjusting the money supply to offset changes in velocity, exchange rate targeting, CPI futures targeting, Divisia monetary index targeting, and NGDP futures targeting. I’m sure there are many other options. But interest rate targeting (which underlies all of New Keynesian economics) has been an unmitigated disaster for American workers. And given that rates are likely to frequently hit the zero bound in future recessions (as trend productivity growth and population growth both slow) NK policy will fail us again and again in future recessions, i.e. when we most need it to be effective. Our current monetary regime is roughly like a car with a steering wheel that works fine—except when driving on twisting mountain roads with no guard rail.
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13. April 2012 at 05:22
Question: Is there such a thing as a Fed “do-nothing” strategy?
Let’s define a “do-nothing” strategy that is neither a tight-money policy nor a loose-money policy; neither a high-interest-rate policy nor a low-interest-rate policy; neither an expansionary credit policy nor a retractionary credit policy. Let’s further define it as a strategy that does not involve active work to maintain, i.e. a “do-nothing” strategy must be laissez-faire; it shouldn’t have to be constantly tinkered-with by humans or machines.
Sorry if this is an incredibly naive question, but it’s one that I think is worth answering. Without injecting any value judgements into the discussion, I’m genuinely curious whether anyone believes it is even possible for the Fed to *do nothing*. Or, is every action — and more importantly every *absence of action* — on the part of the Fed either expansionary or retractionary?
Thoughts?
13. April 2012 at 05:29
Hello Scott,
Thanks for your hard work! A brief critique from a non-economist.
You undermine your position by failing to acknowledge that Keynesianism includes federal deficit spending increases to mobilize the unemployed. The low rates we have, the deficits are large but need to be larger. That spending has a political constraint and political implications.
I primarily read your blog, DeLong, and Krugman. You might be reducing you influence by misstating the others position. Your tongue in cheek title to this post is a good example.
Best regards
Dennis
13. April 2012 at 06:03
Ryan, If you abolished the Fed and went to barter, that would be a do nothing policy. As long as the Fed controls the supply of money, they are always doing SOMETHING.
Dennis, You need to reread this post, I said nothing about Keynesian fiscal policy. I was focusing exclusively in the flaws in Keynesian monetary policy. The fact that some Keynesians support fiscal stimulus just shows how flawed their monetary policy regime really is. Fiscal stimulus should not be necessary if the Fed does its job.
You say the deficits need to be larger, but if the Fed was more expansionary even current deficits would be large enough to produce lots more jobs. That’s why the people you cite keep demanding that the Fed do more. I’m simply pointing out that Yellen (who is very Keynesian) says the reason they aren’t doing more is their commitment to interest rate targeting.
13. April 2012 at 06:03
Agreed, but there’s another problem – the Triffin dilemma. I believe that’s a large part of the reason we’re in this mess.
People wanted more safe assets to hold and for collateral, than the US government wanted to issue (by borrowing). This created a demand for the transformation of low quality securities to high quality securities through derivatives and insurance.
When the market support for these synthetics failed, the result was a flight to quality, a loss of liquidity and doubts about the solvency/liquidity of counter-parties. We saw a huge spread between the Libor and treasury rates. This created a giant blip in GDP, but much worse, persistent asset deflation, a shortage of collateral and an enormous loss of confidence.
We don’t have a stable, believable long-term solution to this problem, and the sovereign debt crisis has made a bad situation worse.
How will NGDP targeting solve this problem? Is there something additional that needs to be done?
13. April 2012 at 06:47
Perfect blogging. A-1.
Given what happened in Japan, it is time to stop thinking of QE as “unconventional.”
That is not a divine definition; it is only “unconventional” or “conventional” if we say so.
There may be a tendency of modern economies, in an era of global capital gluts and real estate busts (and tight money Theo-Monetarists) to sink into recession and zero-bound interest rates.
Ergo, Market Monetarism has to become to new conventional policy.
If you seek the security of price stability and forgo economic growth, soon you will have neither.
13. April 2012 at 06:58
To be fair to the Keynesians, most of them have not ceased in their advocacy for “more inflation.”
They aren’t exactly stuck at the zero bound, because there is nothing in the Keynesian theory that says “The Fed shall not inflate any more because we’re at the zero bound, and at the zero bound the Treasury takes over.”
DeKrugSummers has been calling for more inflation since forever.
13. April 2012 at 07:25
Peter N If NGDP had grown much faster over the past 4 years, then RGDP would have also grown faster. In addition, falling NGDP was the main cause of the financial crisis, even more important that the sub-prime fiasco or the Greek debt problem.
Ben, Yes, we need an instrument that doesn’t freeze up at zero rates. Market monetarism is the best approach.
MF, But the Fed says they aren’t doing it, even though the Fed admits it’s needed, solely because of the fact that they are using precisely the policy instrument recommended by the Keynesians.
13. April 2012 at 07:38
ssumner:
MF, But the Fed says they aren’t doing it, even though the Fed admits it’s needed, solely because of the fact that they are using precisely the policy instrument recommended by the Keynesians.
But do you agree that most Keynesians are calling for more inflation? If you agree with that, then how can it be that while Keynesians are calling for more inflation, they are at the same time acting as an intellectual constraints on the Fed from inflating more?
If you agree that most Keynesians are calling for more inflation, then wouldn’t it be wrong to say that the Fed is not inflating more on the basis that they’re listening to most Keynesians?
13. April 2012 at 08:12
Peter N.
I completely disagree with:
“This created a giant blip in GDP, but much worse, persistent asset deflation, a shortage of collateral and an enormous loss of confidence.”
Well, I disagree with the “much worse.”
If there would no blip in GDP, I would be happen. In my view, “asset deflation, a shortage of collateral, and an enormous loss of confidence.” are problems to the degree they contribute to the giant blip created in GDP.
Anyway, the market monetarist solution to the “shortage” of assets follows automatically from our rule. The Fed creates as much base money as needed to keep nominal GDP on the target growth path. If there is really a problem, (which there might not be,) it will be solved when the Fed has already bought up all of the short and safe assets and has to start buying longer and risky assets.
How the problem would show up in a market monetary scenario is that the Fed would have a huge balance sheet and be holding lots of risky and long term assets. The revenue generated by the Fed for Congress would be less, because it would be suffering losses on some of the assets it owns.
There are a variety of solutions to that problem. Having the Treasury shift its borrowing to short rather than long. Having big budget deficits funded by short assets. Having the real interest rate on short and safe assets lower–more negative is possible too. I favor privatizing hand-to-hand currency, and having negative nominal interest rates on short and safe assets. However, switching to a higher growth rate for nominal GDP and generating a permanetly higher trend inflation rate so that real short and safe assets can be lower is possible too.
But this “problem” about the Fed’s balance sheet has _nothing_ to do with keeping nominal GDP growing on target.
It is all about the Fed’s prefered policy approach of targeting short and safe assets.
If they targeted long and risky interest rates, they could still use an interest rates, if they insisted.
But no. They are used to making periodic adjustments in short and safe interest rates, and expect the rest of the interest rates to move along. And when they hit zero, they are stuck. Rather than admit that they have a bad approach, then blame the economy.
13. April 2012 at 08:14
Our current monetary regime is roughly like a car with a steering wheel that works fine””except when driving on twisting mountain roads with no guard rail.
That was just such a cool sentence, I wanted to repeat it here.
13. April 2012 at 08:21
Scott,
I agree with MF here. Keynesians have been unceasing proponents of greater inflation regardless of the fact that interest rates are at 0%. If anyone is to “blame” for the lack of inflation, it is the free-market economists I support who don’t believe that greater inflation would actually be all that beneficial. It is the prevalence of this policy view that is preventing greater monetary stimulus.
I think there are a fair number of economists who believe like Hayek and Friedman taught me that inflation only boosts production when it keeps coming in higher than expected. If it comes in lower than expected, you get the same effects as deflation. Therefore once serious inflation has started you have “a tiger by the tail.” Either keep accelerating until the money system dissolves put the country through a correction like 1983. or It is this economic view that is getting in the way much more so than the Keynesian view.
If I may digress for a minute, most Keynesians focus on simple AD shortfalls like consumptionist rubes. Lower AD? More money and more spending. They are a bit like the naive store owner who sees that his customers have don’t have enough money and therefore assumes that the cure is giving everyone more money. In fact I’d compare the basic Keynesian fallacy to the idea that the problem in a nation is the same as a problem in a household-a lack of money. As such the Keynesian approach is a reversion to pre-economic ways of thinking.
13. April 2012 at 08:23
Correction: Either keep accelerating until the money system dissolves or* put the country through a correction like 1983.
I should proofread more.
13. April 2012 at 08:41
John:
If I may digress for a minute, most Keynesians focus on simple AD shortfalls like consumptionist rubes. Lower AD? More money and more spending. They are a bit like the naive store owner who sees that his customers have don’t have enough money and therefore assumes that the cure is giving everyone more money. In fact I’d compare the basic Keynesian fallacy to the idea that the problem in a nation is the same as a problem in a household-a lack of money. As such the Keynesian approach is a reversion to pre-economic ways of thinking.
This is an effective, albeit inadvertent, criticism of market monetarism.
13. April 2012 at 08:44
Bill –
“Having the Treasury shift its borrowing to short rather than long.”
This is basically Tim Congdon’s suggestion of “debt management operations”, where the Fed only buys short term Treasuries and the Treasury, in turn sells as many short term Treasuries as the Fed needs. The Treasury may even need to go beyond reducing its sales of long term debt and buy back long term debt previously issued.
Another approach is to change the law to let the Fed loan to the 50 States at the discount rate against future Federal aid so there’s no default risk.
As for the Fed taking a loss, I believe the Fed has 250 million ounces of a useless shiny yellow metal at book value of $42 per ounce, that speculators are currently buying at something like $1600 per ounce. If it doesn’t want to take a one year paper loss for political reasons, it could unload some of that (or preferably all of it).
13. April 2012 at 09:04
Major Freedom,
I follow the Austrians and am skeptical at best about market monetarism. Market Monetarism is probably better than what we have now but would I much rather have the Fed abolished all together? Hell yeah.
13. April 2012 at 09:06
MF,
I also think that Keynesians and market monetarists share the same faulty AD approach which I tried to blast in that post you quoted.
13. April 2012 at 09:23
Okay, this is where my limited understanding trips me up. Don’t New Keynesians (most notably Krugman) call for fiscal stimulus when up against the zero bound? If so, how is that using interest rates as a policy tool, and how is it undermined by rates stuck at zero?
Or are you saying (as you often do) that the fiscal stimulus can’t work because it has to be off set by excessively tight money because the fed can’t force rates to go below zero?
13. April 2012 at 09:28
@Peter N,
The Gorton “shortage of safe assets” idea takes the current business model of the big financial firms as given. How is it that these firms did not require so many safe assets only a decade ago? What are they doing now that is so different?
The answer is that they are financing trading positions via repurchase agreements, and the things being repo’d are thus in high demand. The economy worked just fine 15 to 20 years ago without most of these repurchase agreements, so who cares if a shortage of repo collateral means fewer repo’s get done? It is not the Fed’s job to validate whatever Wall Street’s current business model is.
13. April 2012 at 09:45
Of course, Yellen’s “highly accomodative policy stance” consists of keeping nominal interest rates near zero for extended periods of time … the fundamentally mistaken thinking behind which has been blasted by Market Monetarists ad nauseam…
13. April 2012 at 10:09
if i were Dallas’ Fisher, heres how id translate the promise to keep rates low beyond the appropriate time (the PK promise to be irresponsible): its like a heroin addict promising to get high to prevent withdrawal (he likes the drug analogies).
which illustrates why this framework just doesnt work I’m
n a post-disinflationary world.
i was disappointed she focused on simple taylor rules.
13. April 2012 at 10:12
oh, i also was disappointed she called policy highly accomodative but mumbled under her breath that its more or less just neutral (i would say neutral just now, not tight, cause we are slogging along at about potential not closing the output gap).
13. April 2012 at 12:26
Some draft tweets:
1. Yellen: Taylor ’99 is in charge of our monetary policy
2. Yellen: Taylor ’93 is young and cruel, good thing we fired him, even though Taylor himself likes Taylor ’93 more
3. Yellen: we need Taylor ’12 with an updated formula that is softer when zero bound is reached
So basically she agrees with you Scott that the median economist is driving the monetary policy. The only difference is that she knows that the name of median economist is John.
13. April 2012 at 13:59
John: Therefore once serious inflation has started you have “a tiger by the tail.” Either keep accelerating until the money system dissolves put the country through a correction like 1983. Not the Australian experience since 1993. It is worth remembering that what Scott is actually advocating is stabilising the growth of aggregate income. How that will pay out in terms of prices and output will vary somewhat in different time periods depending on other factors. And it also means a policy that is stimulative in some circumstances and restrictive in others.
I find a considerable amount of the criticism of MM bizarre since I judge likely outcomes on the basis of the Australian experience with an over the business cycle average inflation target, which is effectively a stabilise-aggregate-income-growth target. And we are in such a better place (in my local area, the cafes have “help wanted” ads) and there is no sign of any inflation break out at all. (And our public debt position is pretty good too.)
Now, we have a housing price issue, but that is because almost all Australians lived in Zoned Zones (i.e. under a regime of land rationing, so supply is constrained compared to demand). While we continue to suffer a permit raj in land use, that is going to be an issue. But it is not remotely the RBA’s fault and, if and when the various bubbles burst, at least we can be confident its response is not going to be unanticipated disinflation.
13. April 2012 at 15:58
Blocked again
13. April 2012 at 16:23
Unblocked again. Apparently it’s my links.
Scott wrote:
“The Fed really needs to move away from using any policy rules with a zero bound. Some non-zero bound tools include Bennett McCallum’s policy rule for adjusting the money supply to offset changes in velocity, exchange rate targeting, CPI futures targeting, Divisia monetary index targeting, and NGDP futures targeting. I’m sure there are many other options. But interest rate targeting (which underlies all of New Keynesian economics) has been an unmitigated disaster for American workers. And given that rates are likely to frequently hit the zero bound in future recessions (as trend productivity growth and population growth both slow) NK policy will fail us again and again in future recessions, i.e. when we most need it to be effective. Our current monetary regime is roughly like a car with a steering wheel that works fine””except when driving on twisting mountain roads with no guard rail.”
Why the extensive requote? It was so good. I’m saving that for future paraphrasing.
13. April 2012 at 18:16
MF, Actually I’m not sure if “most Keynesians” are calling for more inflation. The Keynesians at the Fed certainly are not.
Janet Yellen is a Keynesian, She supports the failed policy of interest rate targeting. She wrongly claims that unconventional approaches are “risky.” So I’m not willing to give Keynesians a pass.
Thanks Don.
John, You said;
“Keynesians have been unceasing proponents of greater inflation regardless of the fact that interest rates are at 0%.”
Completely false. Keynesians ignored monetary policy in late 2008 and 2009, claiming that it was ineffective once rates hit zero. They recommended the highly ineffective fiscal approach.
You said;
“I also think that Keynesians and market monetarists share the same faulty AD approach which I tried to blast in that post you quoted.”
It’s clear from your comment that you know little about market monetarism. We aren’t trying to boost consumption, like the Keynesians are. Nor are we trying to boost inflation, like the Keynesians are. We want stable NGDP growth.
Adam, I’m saying they prefer interest rates as a tool. And if you use interest rates as a tool then monetary policy becomes ineffective at the zero bound. Of course they want to use other approaches at that point, but those other approaches don’t work well and wouldn’t be needed if we had a better monetary policy that wasn’t reliant on interest rate targeting.
Saturo, That’s right.
dwb, You said;
“oh, i also was disappointed she called policy highly accomodative but mumbled under her breath that its more or less just neutral (i would say neutral just now, not tight, cause we are slogging along at about potential not closing the output gap).”
I noticed that too–very odd.
123, Even better, let’s dispense with Taylor rules entirely.
Thanks Mark, Comments with more that one link have to be approved. I’d like to change that but don’t know how.
13. April 2012 at 18:27
Scott, you don’t understand. I’m a quoted car expert. When you said:
“Our current monetary regime is roughly like a car with a steering wheel that works fine””except when driving on twisting mountain roads with no guard rail.”
I took that seriously.
I understand that on two levels.
13. April 2012 at 21:27
@bill woolsey
We actually pretty much agree. If the Fed working with the other central banks could sell $2 trillion of US government securities and use the money to buy $2 trillion of higher risk assets, then the collateral shortfall would be resolved.
This is a somewhat different channel from open market operations. The money supply is relatively unaffected. This isn’t like NGDP targeting, it would, however, make NGDP targeting work more efficiently.
” In my view, ‘asset deflation, a shortage of collateral, and an enormous loss of confidence.’ are problems to the degree they contribute to the giant blip created in GDP.”
If the Fed had acted as you propose:
“If there is really a problem, (which there might not be,) it will be solved when the Fed has already bought up all of the short and safe assets and has to start buying longer and risky assets.”
problem solved, but they didn’t. Arguing about cause and effect isn’t very useful. The solution is the same as is the result. Does it matter what you call it?
Then the collateral problem isn’t inherently “even worse”. What makes it even worse is the greater institutional resistance to a solution. A bad problem which you don’t have the will to fix is worse than a bad problem where you do.
In particular, it’s a bad problem to let fester. Confidence is more easily lost than gained.
13. April 2012 at 21:48
“The economy worked just fine 15 to 20 years ago without most of these repurchase agreements, so who cares if a shortage of repo collateral means fewer repo’s get done? It is not the Fed’s job to validate whatever Wall Street’s current business model is.”
The destruction of that much credit is very deflationary and has a strong negative effect on NGDP. Any solution that plugs the hole will work. You don’t have to give the money to the banks. In Australia, they concentrated more on giving money to individuals. It worked fine – better than what we did.
As for Wall Street – too big to fail is too big to allow.
And why haven’t we sent more bankers to jail? For instance, last I looked, wholesale forgery of documents was a crime. Maybe it’s only retail, and for wholesale you get a discount. Bring out the comfy chair.
14. April 2012 at 05:09
Mr. Median Economist tightens the policy:
http://johnbtaylorsblog.blogspot.com/2012/04/references-to-policy-rules-in-speech-by.html
14. April 2012 at 05:13
“Even better, let’s dispense with Taylor rules entirely.”
IMHO system where the current IOR is set according to the rule, and quantity of base money is set so FFR futures trade at the levels that indicate the zero output gap and 2% inflation 2 years ahead would be quite workable.
Of course, NGDPLT futures convertibility would be even better.
14. April 2012 at 08:53
@Peter N,
If “the destruction of that much credit is very deflationary and has a strong negative effect on NGDP”, then why didn’t it’s creation in the decade prior to the financial crisis create a lot of inflation? Credit is not money. Creating too much money is inflationary. Creating too much credit is foolish, but it’s not inflationary unless accompanied by too much money.
14. April 2012 at 12:43
Thanks Mark.
123, You said;
“IMHO system where the current IOR is set according to the rule, and quantity of base money is set so FFR futures trade at the levels that indicate the zero output gap and 2% inflation 2 years ahead would be quite workable.
Of course, NGDPLT futures convertibility would be even better.”
I agree. Are you allowing for negative IOR?
14. April 2012 at 14:39
“then why didn’t it’s creation in the decade prior to the financial crisis create a lot of inflation? Credit is not money. Creating too much money is inflationary. Creating too much credit is foolish, but it’s not inflationary unless accompanied by too much money.”
Stock was never riskless, either inherently or by derivitization. So there wasn’t the same sort of liquidity squeeze. Stocks were at most 50% marginable. AAA weighted “riskless” securities were 95%+ marginable by repo. That’s a huge difference in leverage.
It WAS accompanied by too much money, since it was used as, in effect, money. When it was “riskless” it was freely exchangeable for money. When it ceased to be riskless, it ceased to be freely exchangeable (exchangeable without a large haircut). There was a liquidity problem. The music stopped and some people no longer had seats.
Also inflation is defined relative to the methodology used to measure it. People seem to forget this. If financial assets were included in calculating inflation, there would have been more inflation. We see something similar in housing price inflation. GDP doesn’t capture it, which is fine until you use GDP methodology in calculating the GDP deflator and then say that’s inflation. The fudge involving imputed rent removes most of housing price inflation.
But on average households do buy houses and securities.
14. April 2012 at 22:59
“I agree. Are you allowing for negative IOR?”
Negative IOR probably is not necessary, as the output gap term in the Taylor Rule makes it a semi-level-targeting system.
On the other hand, when debt/gdp ratio doubles, negative IOR might become necessary.
The good thing is that the Taylor Rule futures are already traded in the CBOT.
I wonder what would Taylor say about this system.
Notice that there are two instruments in this system (current IOR and FFR futures price two year ahead). What are the two targets, and which instrument is responsible for which target?
15. April 2012 at 04:02
@Peter N,
OK, I didn’t realize you subscribed to Humpterian Economics. (“When I use a word,” Humpty Dumpty said, in rather a scornful tone, “it means just what I choose it to mean””neither more nor less.”)
You say AAA securities are money, and inflation includes financial asset prices, although you don’t say how you could possibly measure them, what weights you would use when putting them into an overall index, or any of those messy details without which the word “inflation” signifies nothing.
If you want to discuss economics with people who have formal training in it, you’re going to have to adopt the standard definitions of terms if you want to be taken seriously. Otherwise, you’ll be dismissed as just another crank.
15. April 2012 at 06:20
I’m tired of this idea that you can just ignore what you don’t know how and have never tried to measure. The idea that a complete but incorrect theory is better than a correct but incomplete one has gotten rather tiresome. Nor is it really true. American economists have been relying on it since the 1930s. It’s just rhetoric. Give it a rest.
In fact your entire post is just rhetoric
an argument ad personam
an argument ad ignorantiam
another argument ad personam
Surely you can do better than this.
Civility is also occasionally useful, too, though you have persuaded me in this instance to make an exception.
As for your questions. Start with Gorton and Barnett.
15. April 2012 at 07:04
@Jeff,
Would you believe Ben Bernanke?
http://www.federalreserve.gov/newsevents/speech/bernanke20120413a.htm
15. April 2012 at 08:47
Jeff,
Sometimes when I’m really tired, I ask God why He needed cranks to help anyone.
15. April 2012 at 19:34
@Peter N,
You can make an argument that inflation is a fall in the value of a unit of money. Financial assets are one of the things money is exchanged for, so if their money price goes up while the money price of everything else is unchanged, the value of a unit of money has fallen and from that it follows that increases in financial asset prices are inflationary.
The trouble is that to say anything about inflation as a policy matter requires an actual number, i.e., an actual price index. It has long been recognized by many people that deciding which assets to include, and with what weight is problematic. The theoretical answers found by Alchian and Klein in a 1973 paper give such a large weight to unstable asset prices that the resulting index inherits is too unstable to be useful. The issues are covered in a 2001 Economic Journal article by Charles Goodhart “What Weight Should be Given to Asset Prices in the Measurement of Inflation?”. You can find it online.
My point is that people have considered these issues, and the consensus position, which Goodhart actually disagrees with, is that indexes which include only the prices of goods and services are the most useful way to measure inflation.
Personally, I think Goodhart makes a pretty good argument, but he has not convinced most monetary economists. Moreover, I suspect that if he were to refer to his opponents arguments as “tiresome” without proposing anything better, or misused polysyllabic Latin phrases in an attempt to intimidate them with his erudition, it wouldn’t help his cause.
I asked a very reasonable question of you. You said that a shortage of repo collateral would lead to a destruction of credit that would be deflationary. I challenged that by pointing out that the creation of all that had not been inflationary.
Your response was to switch to nonstandard definitions of the words “inflation” and “money”. Pointing out what you did is not a personal attack, and pointing out that your idiosyncratic definition of inflation is flawed is not an argument from ignorance.
Becky, I don’t understand what you mean.
15. April 2012 at 20:19
@Jeff
You said to Peter N:
“You said that a shortage of repo collateral would lead to a destruction of credit that would be deflationary. I challenged that by pointing out that the creation of all that had not been inflationary.”
Of course it was inflationary. Without creation of that credit, a looser monetery policy would have been necessary to hit the same inflation.
16. April 2012 at 04:20
@123
OK, if you believe that, I assume you also believe that looser monetary policy can offset the credit destruction. Either way, it’s not really a problem, is it?
16. April 2012 at 08:32
Jeff,
Yes, looser monetary policy can offset the credit destruction.
The case isn’t closed though, as credit destruction affects on only the expected AD, but also the expected variance of AD.
16. April 2012 at 08:43
123:
Yes, looser monetary policy can offset the credit destruction.
No, it can’t, 123. Not when a substantial portion of new money creation enters the economy in the form of credit expansion, which is debt, and not when inflation gives incentives to borrow more money.
17. April 2012 at 11:12
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