Missing dish on Krugman´s menu

Krugman has an interesting post that fiddles around with Larry Ball´s recent psychoanalysis of Bernanke´s about face, especially if you compare BB today with the BB who 12 years ago wrote on the Japanese “Self-induced paralysis”.

Essentially Krugman sets up two policy menus to reflect BB´s, respectively, pre and post 2003 views.

Menu A comprises:

– Targeting long-term interest rates
– Currency depreciation
– Money financed deficit spending
– A Krugman-style inflation target (note that he doesn´t simply say “higher inflation target”)

Menu B comprises:

– Guidance on future short-term rates (the rates the Fed sets)
– Purchases of long-term bonds and other nonconventional assets
– “Oversupplying reserves”, that is, just pushing up the monetary base

And after a bit of discussion concludes:

You can see where I’m going here. Menu B is, if you like, safer for the Fed than Menu A, because it is defined in terms of actions rather than results; the Fed can point to what it is doing, rather than announce a target for long-term rates or inflation that it might fail to hit. So Menu B serves institutional objectives better. Unfortunately, it doesn’t do the job for the economy. To be fair, we don’t know that Menu A would, in fact, be sufficient. But Benanke the Younger — BB before he was assimilated by the Fedborg — would have said that this was no reason not to try.

But the conclusion is not the exact description of the difference that Krugman discussed. Before, Krugman writes:

Well, here’s my take: Menu A involves the Fed setting targets that can be achieved only if the markets believe that it will persist with unconventional policies even as the economy recovers; ordering from Menu A requires, as I put it lo these many years ago, that the Fed “credibly promise to be irresponsible”. Menu B, on the other hand, involves more or less mechanical actions that the Fed can definitely take.

What if you set a target that defines “exactly” where the Fed will stop, i.e. not become, let alone continue, to be irresponsible?

As Krugman correctly notes, all the “targets” in menu A suffer from a credibility problem and that´s the catch. But that won´t be true if the target is a level target, like a NGDP level target, that could be well defined and credibly established from past data and trend (even if it´s present desired (or attainable) level is deemed a bit different from where it was originally thought it should be).

And even BB himself has expressed this view in 1999:

I do not deny that important structural problems, in the financial system and elsewhere, are helping to constrain Japanese growth. But I also believe that there is compelling evidence that the Japanese economy is also suffering today from an aggregate demand deficiency. If monetary policy could deliver increased nominal spending, some of the difficult structural problems that Japan faces would no longer seem so difficult.

Pity he “chickened out”.

3 thoughts on “Missing dish on Krugman´s menu

  1. I don’t understand why Krugman doesn’t embrace level targeting. It’s exactly, precisely, unambiguously like a temporary 4% inflation target, but has the added benefit of building in credibility on two fronts: first, that the Fed will go through with the higher inflation target (there is a clear, nominal, goal variable to shoot for); second, that the higher inflation target is only temporary (until we achieve the old price level trend line).

    FDR knew about this in the 1930s, why is it so hard to understand now? Perhaps slipping one derivative wasn’t such a good idea after all.

  2. Krugman is so close to embracing MM. Maybe he would if he could accept that the GOP will not allow fiscal stimulus. Also, see Japan—they tried plenty fiscal stimulus.

    So we have the Alan Meltzers, John Taylors, Milton Friedman, Ben Bernankes, Frederic Mishkins and Krugmans all telling Japan to go to QE and NGDP.

    But not for the USA.

  3. Krugman links to a pretty good piece by Paul McCulley. McCulley is one of a handful of private sector economists I respect. I was a little disappointed to read his belief in the “liquidity trap” but at least he’s coming from a thoughtful place.

    Three quotes that get to the heart of his logic:
    “Thus, the Keynesian liquidity trap is only a true trap if central banks cannot stir expectations (Eggertsson 2006)”

    “All conclude that negative real rates may not be a sufficient solution to a liquidity trap, as a hangover of excess debt may inhibit new private borrowing.”

    “Thus, to put a spin on the claim of the modern view that a liquidity trap is only a true trap if central
    banks cannot stir inflation expectations, the modern solution to a liquidity trap may only be a true
    solution in a world without debt constraints!”

    Click to access Paul-McCulley-Fellows-Paper.pdf

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