Monetary Policymakers don´t lack the tools, they lack the will!

From Larry Summers:

Global economy: The case for expansion: …The problem of secular stagnation — the inability of the industrial world to grow at satisfactory rates even with very loose monetary policies — is growing worse in the wake of problems in most big emerging markets, starting with China. … Industrialised economies that are barely running above stall speed can ill-afford a negative global shock. Policymakers badly underestimate the risks… If a recession were to occur, monetary policymakers lack the tools to respond. …

This is no time for complacency. The idea that slow growth is only a temporary consequence of the 2008 financial crisis is absurd. …

Long-term low interest rates radically alter how we should think about fiscal policy. Just as homeowners can afford larger mortgages when rates are low, government can also sustain higher deficits. …

First off: the level of interest rates do not define the stance of monetary policy. This and reasoning from a price (or quantity) change are the most common conceptual errors made by economists of all stripes, including Prizewinners!

Even those like Bernanke, who know best, having stated very clearly in 2003 that interest rates are not a good indicator of the monetary policy stance, saying we should look at NGDP (or inflation, but let us leave that one aside, not only because it is far below “target” everywhere that counts).

The chart indicates that for a significant fraction of “industrialized economies”, monetary policy has been “tight”, certainly not “very loose”!

Lack of will

Prior to the crisis, nominal spending growth was the same in the US and UK (around 5.4%) and much lower in the EZ (4.2%).

Note that after the initial pullback from the deep recession, the ECB under Trichet pulled the brakes hard in early 2011, throwing the EZ economy back into hell. Meanwhile, in tandem, the US and UK said “that´s enough nominal spending growth” (4%). No wander inflation languishes (as does real growth and employment).

Why did all those central banks, the ECB more radically, put a premature stop to the recovery? The obvious answer is fear of breaching their inflation target, even for a “moment”!

In that they sorely lacked what came to be called a “Volcker moment” (or, to paraphrase FDR, a “Volckerian Resolve”). Ironically, or maybe not, the country that has been in hell for longer, Japan, is now trying to get back to savoring some “worldly goods”. Let´s hope the others “get smart” more quickly!

On October 6 1979, the Fed made an announcement (HT David Andolfatto):

Lack of will_1

We know that didn´t cut it. Inflation was only brought down permanently when NGDP growth was adjusted down:

Lack of will_2

Now the Fed (and others) have to adjust NGDP growth up. But please, not through more government (which Japan´s experience also shows doesn´t have lasting effects).

4 thoughts on “Monetary Policymakers don´t lack the tools, they lack the will!

  1. Great blogging. I agree. Summers should ask Japan how well creating negative supply shocks with big government helps to make the inflation nutter central bankers even crazier.

  2. The ideas expressed here and at themoneyillusion seem so obviously true, that I just can’t wrap my brain around how people as smart as Larry Summers and Paul Krugman can think otherwise.

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