Ryan Avent on America’s self-induced paralysis

The entire article is excellent, but I especially liked the way Ryan Avent framed the issue of monetary policy:

What Mr Kohn and Mr Diamond are actually saying is not that the Fed can’t do more, it’s that it won’t. Why, indeed, would expectations change under current circumstances, given a central bank that is clearly uncomfortable trying to raise them? The right question for Mr Klein to ask of the Fed is why it has been reluctant. And it has. According to yields on 10-year TIPS, expectations for annual inflation over that timeframe haven’t risen to 2.7% during the whole of the recovery. According to the Cleveland Fed’s estimates, 10-year inflation expectations haven’t risen above 2.1% since the end of 2008. At least three times during that span, the Fed has halted or reversed its easing, first by ending its initial asset purchases, then by allowing its balance sheet to contract naturally as securities matured, and then by ending the asset purchases known as QE2. Expectations have remained in check because the Fed has opted not to continue policies that would raise them. The myth of Fed helplessness is just that.

The history presented in the Reinhart-Rogoff research suggests that excessive central bank caution is another common feature of post-crisis recessions. Japan, whose “self-induced paralysis” Mr Bernanke himself has criticised, is the most obvious example. And perhaps the story here is also one of political constraints; maybe central banks just aren’t that independent, and it’s therefore difficult for them to do what’s necessary to return an economy to full employment. And in fairness, Mr Klein mentions the Ron Paul and Rick Perry reactions to Fed easing.

But it’s important to get this story right. It would be one thing to forgive Fed caution because people don’t like the idea of using inflation to erode debts, and maybe the Fed is helpless anyway. It’s quite another to add to the list of policy failures the fact that the Fed sat on its hands when it might have returned the economy to full employment because it was reluctant to accept even 3% inflation. And frankly, the rest of it””the too-small fiscal stimulus or the too timid housing policy””is small beer by comparison. Just as the conduct of monetary policy was the crucial difference in the magnitude of the Depression and that of the Great Recession, the conduct of monetary policy has been the crucial difference between the present, disappointing recovery and one in which a long-period of cyclical unemployment is not a prominent feature. Not the only difference, but certainly the biggest.



15 Responses to “Ryan Avent on America’s self-induced paralysis”

  1. Gravatar of Morgan Warstler Morgan Warstler
    11. October 2011 at 05:11

    I don’t think this logically follows:

    “To successfully touch off sustained inflation, for instance, the Fed would have to eliminate enough cyclical unemployment to begin pushing wages up.”

    The top half of earners consumes the HUGE MAJORITY of goods, and ALL the luxury goods.

    They all have jobs. To successfully touch off inflation, you’d just need then to “a bit” buy more from each other, and get paid accordingly.

    More Internet consumption, higher wages for webheads, etc.


    The real structural issue is that we are NOT going to hire more teachers, there will be less teachers over time.

    It doesn’t appear we are going to clear housing stock till 2020.

    I’d say we ought to come to terms with this basic idea: the haves (the top half) are pretty immune from the machinations of the have-notes.

    The 53% KNOW who they are, and they are far more concerned with getting real CHANGE out of the bottom 47%, not giving up anything themselves.

    The fastest possible solution is therefore that which renders unto the 53%, and that means wholesale re-jiggering of the social safety net and public servants.

    WHY fight the future?

    Our solutions are simple in hindsight, and we all KNOW that there won’t be a post office, we all KNOW the public employees are done, we all KNOW the education bubble is over…

    So let’s just do what we know is happening – we have 20/20 vision looking forward on this stuff.

  2. Gravatar of Bill Woolsey Bill Woolsey
    11. October 2011 at 06:05

    During the Volker-Reagan recovery from the 1982 recession, nominal GDP rose at a 9% annual rate for 1983 and 1984. Over the two year period, it rose over 19%.

    The output gap nearly closed. Real GDP grew at a 6% annual rate for those two years, going up about 12%.

    Yes, the inflation rate was 3% over those two years and the price level did rise about 6%. That was unfortunate. That wasn’t the goal. Quite the contrary.

    And higher inflation should not be the goal today. It may be an unfortunate side effect of raising nominal GDP back to a higher growth path.

    As long as we are working with new growth paths below the trend of the Great Moderation, the notion that this somehow unachor’s inflation expectations is wrong. With a nominal GDP growth path target, the expected price level at any future time is the target for nominal GDP divided by the expected potential output of the economy. This is much better anchored than no more than 2% higher next year from wherever it happens to be today.

  3. Gravatar of Bill Woolsey Bill Woolsey
    11. October 2011 at 06:06

    P.S. And no lower next year than today.

  4. Gravatar of John John
    11. October 2011 at 07:11

    I think everyone has lost their minds.

    Biggest stimulus ever= too little

    biggest deficits ever= too small

    most aggressive monetary policy ever= too timid

    Get out of the ideological dogma and forget the models which say that deficits, stimulus spending, and inflation are good for an economic recovery and ask yourelf “What would the world look like if these things were actually poison?” It would look exactly like the one we live in.

  5. Gravatar of Benjamin Cole Benjamin Cole
    11. October 2011 at 08:24

    Another spot-on post by Scott Sumner.

    The value of nominal GDP targeting is becoming more and more clear.

    The immense danger of targeting inflation is also becoming clear.

    The goal is prosperity. If the Fed targets nominal GDP, it gets very close to that goal, with some risks of inflation (but probably not much in the current context).

    If the Fed targets historically low inflation rates, it can hit that target–and end up miles away from the real goal, and that is prosperity, growth.

    From the example of Japan, and from the USA 2008-11, can anyone say that a central bank hitting an inflation target will ever lift a country out of extremely slow growth?

    Other than a boutique nation like Switzerland, are there examples anywhere of major nations roaring out of a deep real estate bust-recession while keeping inflation under 2 percent?

    indeed, given the drag of real estate debts after a bust, is it even possible to recover from a real estate bust-recession without moderate inflation?

  6. Gravatar of Frank in midtown Frank in midtown
    11. October 2011 at 08:57

    We haven’t lost our minds, but you don’t seem to have a very good grip on the your “facts.” Your “largest” stimulus wasn’t even the largest in the world. The Chinese economy is a quarter the size of the U.S.’s and the Chinese stimulus was larger than the U.S.’s(btw, the Bush tax cuts were a larger stimulus.) The deficit is a result of crashed GDP resulting in too little income (only FDIC/financial bail-outs kept spending up.) And, yes, in the face of history’s largest fall in world trade and the total failure of the deregulated banking industry, “most aggressive monetary policy ever” does equal too timid.

  7. Gravatar of John Thacker John Thacker
    11. October 2011 at 13:51

    the total failure of the deregulated banking industry

    And also the total failure of the regulated banking industry.

    And yet, not a total failure of the Canadian banking industry, which never had any sort of restrictions like those repealed by Gramm-Leach-Bliley. So I think that discussing the “deregulation” of the banking industry is as much a side show to your other points as invocation of the CRA is among some right-wingers.

    My one objection to Avent’s post is that he focuses way too much on the central bank changing expectations of future inflation, and not just on the central bank simply actually creating NGDP. I think we have enough evidence that Bernanke promising that “we have the power and we’ll do it if we need to” alone isn’t enough.

  8. Gravatar of John John
    11. October 2011 at 14:14

    Frank in midtown,

    Comparing China’s stimulus to ours is irrelevant. China was never facing recession, and their stimulus was only slightly larger as a percentage of GDP, not in nominal terms. Furthermore, the Chinese didn’t spend around a trillion dollars bailing out their banking system.

    If you read the economists, deficits are supposed to be countercyclical. As people go unemployed, social support programs kick in and revenue falls thus government grows as a percentage of GDP. Dust off the textbooks, those additional government spending measures and deficits are supposed to be stimulative and we have the largest peacetime deficits ever right now.

    I’ll agree with you that tax cuts are far better than government spending but not because they “stimulate.” Tax cuts give people greater incentive to work and boost efficiency because people are better at spending money to suit their needs than the government is at doing that for people. In any case, right now we have the Bush tax cuts, the stimulus, zero interest rates, and the worst economy ever. If the conventional models about fiscal and monetary stimulus were correct, our economy would be soaring.

    When you say the failure of the deregulated banking industry, I wonder what kind of looney pills you’re on and if you could sell me some. If you’ve ever worked in finance, banking, or healthcare, you’d know that large portions or revenue and work hours go to compliance. In fact compliance costs make up around 10% of GDP. I work in finance and we can’t keep even whiteout in our office (yes, regulators come to the office and check). Banking and finance are incredibly regulated; go work there if you don’t believe me. Interestingly, these three industries are the least efficient in America. Coincidence?

  9. Gravatar of John John
    11. October 2011 at 14:17


    1. The FDIC means people don’t have to worry about the bank losing their money

    2. Bailouts and lose monetary policy mean that banks don’t have to worry about losing the people’s money

    This adds up to a complete lack of market discipline that no amount of regulation could fix without outright socialization.

  10. Gravatar of Bill Woolsey Bill Woolsey
    11. October 2011 at 15:55


    You are wrong about “loose” monetary policy.

    Banks can still fail in nominal GDP grows on target.

  11. Gravatar of ssumner ssumner
    11. October 2011 at 16:45

    Morgan, Even rich people like me have very sticky wages. Nothing the Fed does will dramatically impact my pay for quite some time.

    Bill, I agree that NGDP should be the target, not inflation.

    John, Money is tight, interest bearing reserves aren’t “monetary stimulus.”

    John Thacker, I also like the Canadian system. Canada doesn’t have more or less regulation than the US, they have better regulation.

  12. Gravatar of John John
    11. October 2011 at 17:20

    Bill, banks can fail in any environment where the government and central bank will let them. Right now we don’t have that environment hence we have no market discipline.

    Scott, What is you definition of monetary stimulus then? The primary methods central banks use to stimulate the economy are open market operations which add (now) interest bearing reserves. It’s up to individual banks to create the stimulating effect by making loans.

  13. Gravatar of John John
    11. October 2011 at 17:28

    Scott and Bill,

    Fine, monetary policy may not be loose (sorry for the dumb spelling error) by your standards, but the Fed rapidly reinflated the stock market, drove up commodity prices, and injected tons of liquidity by more than doubling the monetary base in early to mid 2009.

    These measures made it much easier for banks which had made a lot of bad loans stay in business, creating a huge moral hazard and removing market discipline. We had the policy with the Greenspan Put as well. However, it’s very important for economists to ask what the cost of the bailout was. By diluting the money supply to save the banks, Bernanke and Paulson essentially imposed a large tax on the holders of dollars. Prices would have fallen much farther relative to what happened, these falling prices would have redistributed wealth to those that didn’t profit from the housing bubble or were able to correctly anticipate the housing crisis.

  14. Gravatar of John John
    11. October 2011 at 17:32

    Will you guys admit that the Fed and Treasury worked together to bail out the banks and that this creates a moral hazard and creates a more unstable banking and financial system down the road?

  15. Gravatar of ssumner ssumner
    13. October 2011 at 05:37

    John, You said;

    “Will you guys admit that the Fed and Treasury worked together to bail out the banks and that this creates a moral hazard and creates a more unstable banking and financial system down the road?”

    Admit it? I’ve been screaming about this problem for decades.

    Monetary stimulus is a policy that leads to faster expected NGDP growth. There are many ways to do it.

    The Fed didn’t “inflate” the stock market in 2009, it took its foot off the stock market’s neck after March 2009. Prior to that it had cut stock prices in half on fears of an outright Depression. Stocks prices are still far below normal levels.

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