Steve Williamson should change the name of his blog from “New Monetarist” to “New Fisherite”!

Noah Smith comments on John Cochrane. Noah updates to consider Steve´s comments:

Steve also has a post responding to mine. Particularly interesting is the argument that Volcker’s rate hikes in the early 1980s actually made the inflation situation worse, and that it was his subsequent rate cuts that actually whipped inflation. I’m probably more open to that story than most people, but I think there are a number of things about it that are very fishy, e.g. the fact that inflation started going down after the rate hikes instead of rising further.

A clear indication that interest rates do not define the stance of monetary policy! What really went on is described in the charts below.

In the top chart you, like Steve, see that inflation is going up while the FF rate is climbing and coming down when the FF rate is falling (“kudos” for “neo fischerism”).

The bottom chart shows that in fact monetary policy (NGDP growth) is guiding inflation. Rising interest rates do not mean monetary policy is tightening. Rising NGDP growth is telling us that monetary policy is “easy”! Then, the “inflation expectations-changing recession” came along, associated with the steep fall in NGDP growth. If you look at interest rates, you could believe monetary policy was getting “easier”!

Noah S-SW_1

Noah S-SW_2

The final charts show the behavior of ten-year inflation expectations (only available from January 1982). It tumbles when NGDP growth is forcefully restrained. Note how inflation expectations briefly (and mistakenly) rise when the Fed steps on the “spending pedal” to get the economy back up, as reflected in the drop in the unemployment rate! This sort of “spending spike” is what didn´t happen after the 2008 NGDP dive, leaving the real economy in a “depressed state”!

Noah S-SW_3

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