DeLong asks the right question…

And gets to the answer convincingly. A few days ago, he was concerned with the “anatomy of slow recoveries”. Now he asks himself “How did we get here”? And the answer jumps at him:

I thought that the Federal Reserve had the power and the will to stabilize the growth path of nominal GDP. He was not called “Helicopter Ben Bernanke” for no reason. When demand for currently-produced goods and services is crashing because households and businesses find themselves desperately short of the safe, liquid vehicles of appropriate duration in which they want to park their wealth and so are not-spending in order to build up their safe, liquid, appropriate duration asset holdings, it is the job of the central bank–and of the Treasury through banking policy, and perhaps of the Treasury through fiscal policy–to fix it and give the private sector the financial assets it wants. No excess demand for financial assets, and by Walras’s Law there can be no deficiency of demand for currently-produced goods and services and labor in general.

Skipping a paragraph:

Demand management worked in spite of a number of large shocks from the mid-1980s to the mid-2000s. Black Monday in 1987. The S&L crisis of 1990. The Mexican peso crisis of 1994. The East Asian crisis of 1997. The Russian state bankruptcy. LTCM. The collapse of the dot-com boom. Assorted Brazilian, Turkish, Argentinian, and other episodes. In all these the Federal Reserve, without breaking a sweat, intervened strategically in financial markets to successfully build a firewall between financial panic and distress on the one hand and effective demand for goods, services, and labor on the other. And so we all began writing papers on the “Great Moderation.”

And more:

But I don’t think I was wrong because the government does not possess the power. I think I was wrong because the government does not possess the political will to do what ought to be done and the technocratic clarity of thought to understand what strategic interventions in financial markets are likely to work and what ones are likely to simply be wastes of money.

To which Nick Rowe gives the perfect appraisal in the comment section:

One thing I think is missing is this: how much of the failure of political will was really due to the New-Keynesian/Neo-Wicksellian perspective? “What the central bank does is set the nominal rate of interest, and so when the nominal rate of interest hits zero, it can do no more”?

You are a historian of thought (inter alia). You have read stuff that wasn’t published yesterday. Most economists haven’t. They found it very hard to think outside that “monetary policy is setting the interest rate” box. They couldn’t communicate monetary policy outside that box.

It was less a failure of political will than an atrophy of thought about monetary policy. The grandchildren of Tobin and Friedman’s marriage had invested all their inheritance in a single asset — The Federal Funds rate.

Update: Scott Sumner reminds me that once upon a time DeLong did not believe in the efficacy of MP to get the economy back on it´s feet. In this letter to the editor from 2009 he comments on DeLong´s views at the time.

2 thoughts on “DeLong asks the right question…

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