Menzie Chinn is an ardent defender of fiscal stimulus:
The view that the impact of government spending was relatively small was common to analysts with both the Keynesian and New Keynesian perspectives. One reason that view proved wrong was that experts predicated it on “normal times”. But the times were hardly normal, for at least three reasons:
- Short term interest rates remained stuck near zero for more than five years, what is called the zero lower bound.
- The extent of economic slack was much greater than experienced during other recessions after World War II.
- The financial system was severely impaired.
The intellectual landscape half a decade after the Great Recession is quite different than it was a decade ago. Mainstream macroeconomic thought took the stable growth-low inflation environment of the previous 20 years as the norm. It assumed that the financial system had evolved to be robust to asset booms and busts. These assumptions proved grossly wrong, and so the need to re-assess many of the conclusions that followed is unsurprising.
Mainstream macroeconomic thought did not assume anything of the kind. The stable growth-low inflation environment of the previous 20 years was the result of an unprecedented nominal stability which the Fed was kind enough to provide; and which the financial system, a part of the macroeconomy, also enjoyed.
When that nominal stability was jilted, the whole economy, not only the financial system, suffered.
The picture below provides a startling example. When the Fed allowed (because of its fixation on inflation, and the wrong inflation indicator at that) aggregate nominal spending to tank (to an extent not seen since 1937), not even a robust rise in nominal government total expenditures was able to avoid a steep drop in real growth. Just as an even more robust retrenchment in nominal government spending (paradoxically synchronized with ARRA) did not stop real growth from rising on the heels of a more expansionary (more accurately, less contractionary) monetary policy (rising nominal spending).
Serious inflation has been absent from the American scene for years–but for the Federal Reserve, the threat remains omnipresent. Indeed, recently released transcripts show that even in the dark days of the 2008 financial crisis, many Fed officials were more worried about inflation than the economy collapsing around them.
Maybe they’re just born that way.
At their confirmation hearings before the Senate Banking Committee on Thursday, Fed board nominees Stanley Fischer and Lael Brainard dutifully noted the risks of high inflation, while skirting the issue of whether it is too low. This even though the Fed’s preferred measure of core inflation, at 1.1%, is well short of its 2% target. Headline inflation is just 1.2%.
And shows this graphic:
(Note: Although Plosser and R. Fisher are 5 years younger than S. Fisher, the average inflation they experienced in their adult life is higher because the “Great Inflation” period weighs more heavilly on them)
Does anyone harbor any doubt that the prevailing “inflation targeting script” sucks?