Jeffrey Lacker strongly mis contextualizes

In a recent interview, Jeffrey Lacker, when answering the question “So why haven’t we seen faster inflation?” said:

… the historical evidence suggests that there’s some lag before things accelerate as you reduce slack significantly. In 1966-67, we had unemployment at 5 percent, we pushed it to 4, and it was 1967 and 1968 when inflation took off. So there was a significant lag in the way that relationship seems to have worked in the past.

That only shows the degree of his ignorance about economic contexts. As Arthur Okun, an important player throughout the 1960s, and the economist that “invented” the concept of “potential output” reminisces:

“The strategy of economic policy was reformulated in the sixties. The revised strategy emphasized, as standard for judging economic performance, whether the economy was living up to its potential rather than merely whether it was advancing…the focus on the gap between potential and actual output provided a new scale for the evaluation of economic performance, replacing the dichotomized business cycle standard which viewed expansion as satisfactory and recession as unsatisfactory. This new scale of evaluation, in turn, led to greater activism in economic policy: As long as the economy was not realizing its potential, improvement was needed and government had a responsibility to promote it.

The objective was to promote brisk advance in order to make prosperity durable and self-sustaining…The adoption of these principles led to a more active stabilization policy. The activist strategy was the key that unlocked the door to sustained expansion in the 1960s”.

Furthermore, to the economists at the CEA:

The stimulus to the economy also reflected a unique partnership between fiscal and monetary policy. Basically, monetary policy was accommodative while fiscal policy was the active partner. The Federal Reserve allowed the demands for liquidity and credit generated by a rapidly expanding economy to be met at stable interest rates.

However, as Okun recognized:

The record of economic performance shows serious blemishes, particularly the inflation since 1966. To some degree, these reflect errors of analysis and prediction by economists; to a larger degree, however, they reflect errors of omission in failing to implement the activist strategy”.

Funny how often policymakers and commenters fall prey to the “it wasn´t enough” argument, in this case not “activist enough” or, more recently, “the 2009 fiscal stimulus wasn´t big enough” or was “reversed too soon”.

The above is far from being a description of the present context.

I think these points from Ryan Avent´s “Simple rules of thumb” are very relevant to the present context (just as they would have been 50 years ago). They are also consistent with my preference for “experimentation” instead of “estimation” (of all the “naturals” – interest rate, unemployment, output) to which much time and effort is devoted mostly in vain!

4) We know what an economy with way too much demand looks like. It has high and accelerating inflation.

5) We know what an economy with way too little demand looks like. It has high unemployment and deflation.

6) Within those two extremes, it can be tricky to identify exactly where an economy stands: how close or far away from potential output it is.

7) Both too much and too little demand are economically costly, but history suggests that too little demand is far more economically costly and politically risky than too much demand. So policy should err on the side of too much demand rather than too little.

How does “now” compare to the 1960s? For one thing, demand (NGDP) is growing at a relative trifling rate. The charts also indicate that the unemployment rate doesn´t add anything to the story, especially because the unemployment numbers are just not comparable.

Rules of Thumb_1

What happened between those two extremes? Following the 1960s, nominal aggregate demand growth (NGDP) took off at a rising rate (the scale in this chart is different from the others). Inflation was also up with spikes reflecting the oil shocks of the decade that reduced real growth and increased unemployment. Later, during the age of the “Great Moderation”, demand growth was just about right; inflation remained low and stable (with swings reflecting supply shocks).

Rules of Thumb_2

The images are telling us that the FOMC would be much more productive if, instead of eternally grumping about inflation, it moved on to experiment with level targeting nominal aggregate demand (NGDP).

4 thoughts on “Jeffrey Lacker strongly mis contextualizes

  1. Thank you for your interesting and informative post. I think another aspect to consider is the level of private and public debt, relative to GDP. The continuation of deleveraging has surely slowed the recovery from the Great Recession, despite support from monetary and (for a while) fiscal policy. Although there has been a significant reduction in the private debt ratio in the last few years, there is much further to go if further crises are to be avoided in the near future. If the fed can increase nominal GDP at a greater rate, then as long as private and public debt grow at a slower rate than this, then the ‘burden’ of these two liabilities could fall much quicker, and the recovery would become more sustainable, both now and further into the future.

    • Nick, thanks for commenting. What you say is true. But what is also true is that the need for deleveraging would be greatly reduced if the Fed, to begin with, had not allowed NGDP to tank, Debt ratios increased during the Great Moderation. Although that´s not surprising, many feel macroeconomic stability fueled “greater risk taking”. It´s quite the opposite. Debt ratios rose because the risk of taking on debt decreased markedly after 1982. It is also true that particular public policies fomented the increase in debt (especially mortgage debt).
      Kevin Erdman has a lot to say on that:

  2. I can see that targeting NGDP might be helpful, as you say, but is it that easy to influence? If it was too low during the Great Moderation, should interest rates have been even lower during that period? Or fiscal policy more expansionary? I am not convinced that central banks have a huge amount of direct control over the money supply, or at least the money supply that has an effect on growth. In recent years they have dramatically expanded the monetary base, but other broader measures of the money supply have not grown so much. I am sympathetic to the view that this is down to a lack of demand for credit among businesses who are either paying down debt, or else simply reluctant to invest. This seems to have been the experience with quantitative easing in the UK. When firms have reduced their debts sufficiently and there is more incentive to invest, then perhaps broader measures of the money supply will expand more quickly. Having had a quick look at your book on amazon, I suspect you may disagree with this!

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