First, I take it as a good sign that Summers understands that the Phillips curve is not all it's cracked up to be:
...the idea that below normal unemployment will necessarily lead to accelerating inflation as suggested by the so called Phillips curve is very uncertain. Contrary to such predictions, inflation did not decelerate by much even a few years ago when unemployment was in the range of 10 per cent. Nor was there much evidence of accelerating inflation in the 1990s when the unemployment rate fell below 4 per cent.But Summers is trying to make the case that, for the Fed, continuing with ZIRP (zero interest rate policy) would be a good thing. He says:
...if inflation were to accelerate a bit this would be a good thing. It is now running and is expected to run below the Fed target. Prices are about 4 per cent below where they would have been if 2 per cent inflation had been maintained since 2007. So there is a case for some inflation above 2 per cent to catch up to the Fed’s price level target path. There may also be a case for inflation a little bit above 2 per cent for the next few years to allow real interest rates low enough to promote recovery when the next recession comes.So, here he seems confused. If the Phillips curve doesn't explain what's going on, how do we get more inflation with continued ZIRP except through a Phillips curve mechanism? Further, Summers seems worried about the "next recession." Presumably if the Fed still has ZIRP at that point, it's powerless (except perhaps with unconventional tools) to do anything about it.
Next, we enter the realm of the bad analogy:
...a plane that accelerates too rapidly as it takes off may cause passengers discomfort while a plane that accelerates too slowly may crash at the end of the runway. Historical experience is that inflation accelerates only slowly so the costs of an overshoot on inflation are small and reversible with standard tightening policies. In contrast, aborting recovery and risking a further slowing of inflation is potentially catastrophic — as Japan’s experience demonstrates. So in a world where economic forecasts are highly uncertain, prudence in avoiding the largest risks counsels in favour of Fed restraint in raising rates.His assumption, again, is that continued ZIRP will make the inflation rate go up. But "as Japan's experience demonstrates," 20 years of ZIRP just serves to produce low inflation.
"But "as Japan's experience demonstrates," 20 years of ZIRP just serves to produce low inflation."ReplyDelete
Basic undergraduate error, you mistake a correlation for a causation.
The ongoing stagnation, lack of demand has kept inflation in Japan low. If an economy starts to boom inflation will surely go up and the previous expansion of the monetary base increases the risk of inflation rising far. Of course prudent central bankers will counteract and increase rates before this happens. Right now many central bankers are obviously too prudent.
""The ongoing stagnation, lack of demand has kept inflation in Japan low. If an economy starts to boom inflation will surely go up and the previous expansion of the monetary base increases the risk of inflation rising far."Delete
Basic undergraduate error. You think the Phillips curve exists. How does a Keynesian lack of demand persist for 20 years?
"How does a Keynesian lack of demand persist for 20 years?"ReplyDelete
In a liquidity trap it does. But feel free to tell us a supply side story about Japan. And don't try the demographic shift nonsense, all Western countries are experiencing that.
Or why don't you tell us a story about Europe. In your topsy turvy world "structural" factors explain the double digits unemployment rate numbers and the elephant in the room, reduction of public spending, has nothing at all to do with it.
But I guess in the end arguing with Neoclassicals. i.e. a fraction of voodoo economists who are in demand denial (you had 80 years to catch up) and claim that foodstamps caused the Great Depression, is like talking to climate change deniers: it has been and will always be pointless.
It's a little odd that most of what you're supplying is what you think is my side of the argument, but you're not exactly reading my mind here.Delete
Start with "in a liquidity trap it does." Suppose you think that "lack of demand" is due to sticky prices. There's nothing about the liquidity trap that stops prices from adjusting, right? So, to repeat the question, how is the lack of demand supposed to persist for 20 years?
Can't the fed just go into negative rate territory?ReplyDelete
Here's the law governing payment of interest on reserves in the U.S.:Delete
My interpretation is that the law authorizes payment of interest, as long as it's positive. I think a negative interest rate on reserve balances would be interpreted as a tax, which the Fed isn't authorized to levy.
But suppose that the interest rate on reserves could be negative. Indeed, some central banks in the world have entered negative territory. Would negative interest be the solution to anything? Dropping the overnight nominal interest rate into negative territory would have the usual short-term effects - real interest rate falls, maybe inflation goes up, etc. But those effects are temporary. We would still suffer from the policy trap problem I discussed here:
Except the problem is worse. If it's a negative lower bound instead of a zero lower bound, the inflation rate when the central bank sticks at that lower bound for a long time is even lower. I'll write about this in the next post, to expand on the idea.