Let´s be happy. Our models say we can

From the Economist:

The news is generally good, but not good enough. Growth is a bit above trend but still slower than one would expect to see after so deep a recession. So far, growth seems to be tracking at or above the Fed’s projections for the year while unemployment is tracking to the low end of its outlook—and inflation is below the Fed’s target and falling. That suggests that the economy may be farther from potential output and employment than expected, and that the Fed can, and should, push harder to facilitate a rapid recovery.

That would be true even if the rest of the world were in great shape. Given potential threats abroad—especially in Europe—downside risks to growth and inflation are clear and present. This is no time for the Fed to take its foot off the accelerator.

The quote above well summarizes the problem. “Happiness” is associated with growth (a rate of change). The “level” is not so important. We´re “deep inside the ravine”, but since we´re “scrambling” up, that´s sort of OK. Just keep the foot on the accelerator Mr. Fed.

Unfortunately, many think there´s not much the Fed can do. A branch argues for more fiscal stimulus, and to make it “acceptable”, packages it as “self-financing”, with the “owner´s manual” coming complete with equations and the relevant parameter values.

Another branch, which eschews fiscal stimulus, nevertheless, given the dual mandate, argues that, along the path the crisis took, there was a “bifurcation”. On one side, called the “demand for product” shock, monetary policy is doing just fine. You guessed that´s because inflation is close to “target”. On the other side, called the “demand for labor” shock, monetary policy has to be aided by “non-monetary policy” since it´s not doing so well given the drop in employment. No, that´s not your traditional fiscal stimulus, involving government spending, say, on infrastructure projects, but some kind of subsidy to hiring (reduction of employer side payroll tax, for example).

Different interpretations of reality, having in common the fact that monetary policy is either “fully handicapped” because of an “illness” called liquidity trap, or only “partially handicapped” because there´s an “inflation target obstacle” in its way.

The “illness” is pure fiction. The “obstacle” is a “criminal construct”, now officially put in place with the result that the natural solution path is blocked, making it difficult and dependent on hard to obtain legislation to get a “rapid recovery” going.

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