Here I go Again Criticizing Paul Krugman
Again I agree with Krugman and am quibbling. In this case I quibbling about theory due to Krugman not terminology as in the post below. Krugman argues that Bernanke's answer to Brad DeLong's question is insane. I agree with Krugman, but he makes appealing but invalid arguments.
I can't summarize Krugman's argument as well as
he does but the part to which I object is
Future economic historians will, I believe, see this as fundamentally absurd — as absurd as the inflation fears that paralyzed the Bank of England in the early 1930s even as the world went into a deflationary spiral. Yes, there may someday be a 1970s-type episode in which the Fed needs to fight inflation, not encourage it — but it’s a long way off. Furthermore, why on earth would we imagine that the Bernanke Fed, by showing itself willing to inflict gratuitous pain in 2010, would make it easier for whoever is running the Fed in, say, 2020 to control inflation then, let alone that the tradeoff of real pain now versus hypothetical pain much later, if it even exists, is worth making?
I agree with the policy proposal, but I note a logical inconsistency in you (Krugman's) argument. A natural reaction to Brad's question is to ask : how can the Fed cause higher inflation right now when we are in a liquidity trap? The answer, due to uhm Krugman, is that the Fed can't cause higher inflation now, but will be able to cause higher inflation in the future when the economy is out of the liquidity trap.
Krugman's proposal was for the Bank of Japan to commit to a higher inflation target for the fairly distant future when Japan was out of the liquidity trap -- that would be imply, as noted by Krugman, that the unemployment rate is what the monetary authority wants it to be plus or minus epsilon.
So to get a lower long term real interest rate now, the Fed would have to commit to higher inflation at some time when it can target inflation which means at some time when the normal rules hold and long expected inflation does not affect real variables.
The logic of the argument requires that the high inflation target be costly. More to the point, it requires that the Fed can now commit to a future policy different from that which they would choose in the future if they weren't precommitted.
If the Bernanke Fed can't influence beliefs about the someone else Fed, and those are the beliefs that will matter at all times when we would like lower inflation, then the Krugman/DeLong proposal won't work. All the arguments in this post about now vs in the future don't work, because the proposal is to do something different in the future, since the Fed can't cause inflation now except via expectations about monetary policy when the US is no longer in a liquidity trap.
I'd say the valid argument is simpler. The costs of moderate inflation (say up to 10%) are miniscule compared to the costs of 1% more unemployment. Worrying about whether actual inflation will by higher than 3% if target inflation is 3% is like shouting fire fire when you see a gas stove.
One final comment. I think I understand what Bernanke is doing. My hypothsis follows. His aim is to be reconfirmed. He knows reconfirmation won't be blocked by liberal Democrats, but might be delayed by Republicans who are blocking everything. So he wants to convince Republicans that they want to reconfirm them. Therefore he is saying crazy things so that he sounds like crazy Republicans. Also the sane Republicans other than Snowe and maybe collins in the Senate (if any) are evil. They have decided that the worst things are the better things are. Any Republican Senators who understand economics have decided to pretend that they don't aimiing for high unemployment in November 2010.
The terrible thing is that I think Bernanke's calculations are correct. His testimoney is insane nonsense and it is the testimony best designed to get him reconfirmed quickly.
