Friday, January 27, 2012

Wanted: More Inflation

     Bernanke's speech the other day got some positive reviews. Sumner thinks it shows that he's more on the dovish side. Maybe. I think that may be true though I think he may play for the "Center" as is common for the chief executive-this goes back to 19th century France when the Prime Minster positioned himself literally in the center between the conservatives-who sat to his right-and the radicals-who sat to his left.

    He may be dovish but if so he is probably more moderately dovish than the real doves like the Chicago Fed President. Sumner of course couldn't resist discussing how Bernanke and the Fed may react to fiscal stimulus:

    "On the side of a positive multiplier, Bernanke noted that zero interest rates would still be appropriate with an even stronger economy.  That could be viewed as implying that monetary policy is currently too tight.  He did note that there were some risks associated with unconventional policies.  I inferred that he saw these “risks” (which I don’t see as being real) as being one factor holding the Fed back.  So perhaps the fiscal authorities could do something without triggering a monetary tightening."

     "However Bernanke also made a number of statements that cut the other way.  He repeatedly emphasized that they’d be watching the economy closely over the coming months, and the Fed would provide additional stimulus if the indicators weren’t satisfactory.  He kept emphasizing that they take their dual mandate seriously, and that unemployment is too high by any reasonable estimate of the natural rate.  Also that inflation is likely to remain low.  The takeaway for me was that Bernanke made it quite clear that he feels the Fed needs to be active, and how much they do depends on the state of the economy.  That implies a near-zero multiplier.  Or at the very least, that the multiplier is considerably lower than the figure implied by Keynesian models."

    Sumner finally wrote a post that wasn't mainly about razzing Krugman and Keynesianism but he had to slip that in. The new blog Not the Treasury View could not have come at a better time.

    Krugman agrees that Bernanke's speech was at least an improvement but he says that what is also needed is a raise in the long term inflation target. He actually says that we need a long term inflation target of 4-5%. I for one like that idea a lot-a whole lot actually-but I feel like it would be too much of a cognitive dissonance for the hawks on the Fed in the short term.

     When you look at the cumulative statement and votes of the FOMC there is some reason for optimism that we may see a -very-moderately dovish Fed. In the short term I suspect they're not ready for that. Still there is at least some good news-you have a number of ideas out there. Krugman cites Oliver Blanchard the IMF President who advocated the higher inflation target in 2009.

     Note the difference with what Krugman is saying here than with Sumner's prescription. Sumner advocates a NGDP target for the Fed and futures market for NGDP. It's yet another species of Friedman's policy rule to remove as much as possible any monetary distortion-ie, the distortions that money itself is believed to introduce into the pure market economy-as we saw in a previous post, Lars Christensen believes that the pure market economy that Market Monetarism seeks acts like a pure barter economy.

    In theory it would seem that whether we raise the inflation target or we come up with a NGDP target it amounts to the same thing-provided the NGDP target is not too low. If we presume over Keynes' "long run" the U.S. economy grows by about 3% and the inflation target is 2% we could declare a 5% NGDP target.

    This would allow for the time being a higher level of inflation as growth is lower. But it seems to me that the endgame of Sumner and the rest of the Market Monetarists is what they so often claim: a long term "small, gentle" deflation. Sumner's target certainly is not anymore than at most 5.5%. He often talks about a 4.5% rate-this assuming historical GDP-leaves little room for inflation of more than at most 2%. Sumner stresses the idea that once the target is picked it must be stuck to rigidly.

      The idea of Krugman-and Blanchard and others for a 4-5% inflation target would imply a long term NGDP rate of 7-8% way above what Sumner would want I presume. Sumner does say that he thinks if we can't have NGDP targeting he would support inflation targeting as long as it is smoother over. That is to say that even if we insist on the 2% rate, as we have had rate lower than that since 2008 it would be acceptable over the near term to have higher inflation just to smooth the inflation rate at 2%. Again what is different from Krugman and Blanchard is that the higher target is long term
      Blanchard gives an important reason for a higher inflation target in the long term

       "Higher average inflation, and thus higher nominal interest rates to start with, would have made it possible to cut interest rates more, thereby probably reducing the drop in output and the deterioration of fiscal positions.

         Krugman then points to another reason for a higher long term rate

         "I would add, however, that there’s another case for a higher inflation rate — an argument made most forcefully by Akerlof, Dickens, and Perry (pdf). It goes like this: even in the long run, it’s really, really hard to cut nominal wages. Yet when you have very low inflation, getting relative wages right would require that a significant number of workers take wage cuts. So having a somewhat higher inflation rate would lead to lower unemployment, not just temporarily, but on a sustained basis."

         "I think this is especially important in the European context. As I’ve been writing in a number of posts, the period 2000-2008 saw a huge divergence in price levels between the capital-inflow nations of the European periphery and the European core."

        "Almost surely, that divergence now has to be reduced. Yet with a low overall inflation rate for the eurozone, that means large-scale deflation in the overvalued economies if convergence is to happen any time in, say, the next 5-10 years."

         "The task would be a lot easier if the eurozone had 4 percent inflation instead of 2.

        "Blanchard is the President of the IMF and for him to advocate this might seem to indicate hope for the higher target. However this is more his personal view than that of the institution.




  1. I'm only an amateur so far, but to me it seems that targeting inflation is actually missing the point. Krugman and others seem to be believing that if the US, say, were to create greater stimulus, then higher inflation would be the result. Yet with 8.6% unemployment, any higher inflation would only be temporary while production catches up with the increasing demand.

    With the mainstream practice of inflation targeting, Krugman's response is to increase the target, rather than, say, the MMT prescription of tergeting unemployment reduction instead.

  2. I don't know that he rejects targeting unemployment. Fact is there in chance doing that while the GOP has the House.

    I think he'll take what he can get with stimulus.

  3. I mean Charles, speaking of the MMT position, is there any room for the Fed in it's view of the world?