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Saturday, June 02, 2012

My Usual Monetary Rant

Just when I thought I had found a safe corner of the blogosphere, I find Ryan Avent quoted at Political Animal. Matthew Zeitlin quotes and discusses. I excerpt and am very rude in comments.

What’s interesting about Avent’s wonk-and-brimstone and Lahart is that both pieces start from a similar point: the Fed has been willing to step in with an unconventional policy measures when the economic picture has gotten particularly bad. But whereas Avent sees excess caution leading to calamity (“the Fed bears the greatest responsibility for America’s pathetic recovery”), Lahart voices the Fed’s possible concerns with more agressive policy, especially raising expectations of future inflation:

First, take targeting higher inflation. If investors believed the Fed would succeed, 10-year Treasury yields would likely surge, undermining a recovery. Capping yields in such a scenario might require an unfeasibly large expansion of the Fed’s balance sheet and scare off foreign creditors like China

To understand the debate Lahart is rehearsing, you have to understand one proposed unconventional policy measure.


The idea is ... it [the Fed] can resort to announcing — and affecting — future inflation. And since you don’t want to bet against the central bank, this gambit may very well work.

My very rude comment.

Given the demonstrated (again) effectiveness of fiscal stimulus and the almost compete absense of any evidence that the Fed's efforts since the crisis have had much effect, I have no idea how Avent can possibly think that the Fed bears greater responsibility than Congress. I can see an argument for more aggressive monetary policy on the grounds that it certainly won't hurt, but I think Avent's blind faith that it is as effective now as in normal times is based on a refusal to deal with the evidence.

I also think that Lahart's argument has no merit at all. Yes higher expected inflation would cause higher *nominal* 10 year rates, but what should matter in theory and what appears to matter in the data are real interest rates. I do not believe that Lahart can write down an economic model in which higher expected inflation causes lower GDP when the economy is in a liquidity trap (which doesn't mean that no one can -- I am also sure that Kevin Murphy* can write down a model which corresponds to that or any other prediction).

Here I add that scaring off the Chinese implies causing the dollar to depreciate relative to the renmibi. This would be an additional advantage of higher US inflation expectations for the world economy (including the Chinese who are not at the zero lower bound and can stimulate domestic demand). Anyone who thinks that Chinese purchases of dollar denominated securities are dictated by considerations of return and risk (not counting the risk of another workers' revolution in China) has been observing a different world than the one I live in.

Finally, there is a huge difference between the Fed announcing and affecting future interest rates. It would have to affect them in the future, when it would normally want lower inflation. The announcement, if believed, would have desirable effects. The affecting would have undesired effects (otherwise the announcement doesn't amount to a shift of policy). People would have to believe that the Fed will do something which it won't want to do when the time comes. There is no, zero, nada reason for anyone to believe this. The shining example used by those who think monetary authorities can and should do more is Sweden (wow progressives like Sweden what a shock). The Swedish central bank promised to keep interest rates low even if unemployment fell. It broke that promise. This caused the credibility of such announcements to fall from very low to minuscule.

No serious economist is willing to assert that such announcements are effective. Being economists they talk about what would happen if the announcements were credited. Well being economists and not being on good terms with the English language they say "credible" but they mean credited and are miss-using the word.

* update: footnote deleted as too many people would read it.


paine said...

hey you naughty brute
you forget financial repression

nothing can stop the fed from holding down nominal rates eh ?

that i've always assumed was part of the package

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