A “Faustian” reading of history

From John Hopkins´Jon Faust:

Let’s look at what history tells us about episodes like this—that is, episodes in which large economies were mired for a long period with the main monetary policy interest rate at its zero lower bound. In such circumstances, traditional interest rate ease by the central bank is impossible, and the inability to lower rates brings a powerful asymmetry to the policy problem. If the economy were to boom or inflation to rise, the central bank could pursue the standard approach of raising interest rates. There is little mystery here: Sufficient rate increases reliably slow the pace of economic activity and relieve upward pressure on wages and prices.

If, in contrast, the economy were to falter, the traditional response of lowering rates is foreclosed. The central bank would be forced to dig even deeper into its toolbox of nontraditional policy measures. This is a very unattractive option: we have extremely limited experience with these tools, we are unsure about their potency, and we must acknowledge that they may have unintended consequences.

So what does history teach us about how central banks of large economies have dealt with this asymmetry? Setting aside some episodes in smaller economies, there are only a handful of episodes: the Great Depression, Japan after the collapse of the asset bubble in the early 1990s, and the U.S. and euro area at present. Of these, only the Great Depression provides an example of escape from the zero bound, and arguably that escape should be attributed to World War II. There is no clear precedent for a large economy escaping the bound in anything resembling a benign manner.

When you don´t recognize evidence staring in your face, saying “arguably that escape should be attributed to World War II”, there´s really not much hope someone, someday, will do the right thing!

Meanwhile, not understanding how the Great Depression was reversed by monetary policy (FDR´s devaluation by delinking from the gold standard), the US is mired in a “monotonic depression” as illustrated below. But nevertheless, the US is” applauded” because others, like the EZ, are trapped in an “increasing depression”!

Monotonic Depression

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