Zombie Economics Will Never Die

A Benjamin Cole post

The tight-money crowd is dominant in central-bank staffs, and so firmly (and self-perpetuatingly?) ensconced in such independent government sinecures that they look likely to outlast all rivals. That tight-money enthusiasts preach an increasingly dubious religion or ideology—I have dubbed it Theomonetarism—is unimportant. They have allies in media and academia, curiously always on the right-wing side of things (with some exceptions, such as Ramesh Ponnuru at National Review, James Pethokoukis at AEI, and Scott Sumner, of the Mercatus Center at George Mason University).

The latest tight-money sermon comes from Daniel Thornton, an excellent writer and former veep at the St. Louis branch of the U.S. Federal Reserve, who damns the Fed for quantitative easing (QE) and low interest rates, in Requiem For QE, written for Cato Institute.

The Thornton Allegations

Thornton says not only did QE accomplish almost nothing in terms of stimulus, it resulted in “unintended consequences.” From Thornton, “[T]he intention of the (Fed’s) policy is to distort asset prices in an attempt to reduce long-term yields. But such actions produce unintended distortions: a strong and persistent rise in equity prices, a marked change in the behavior of commodity prices, a resurgence in house prices and residential construction beyond what is warranted by economic fundamentals, and excessive risk taking, even by those who are least well situated to take it. These are the unintended consequences of QE and the FOMC’s zero-interest-rate policy.”

Thornton also reiterates that the Fed was kicking Grandma; poor and elderly savers get hurt by low yields. And, of course, Thornton sermonizes that QE and low interest rates threaten injurious inflation down the road.

Where To Start

Like wrestling with a criminal octopus in Sodom and Gomorrah, it is difficult to know where to begin with Thornton. Wrong is everywhere. But let’s just hack away.

  1. Thornton avers QE and low interest rates cause “a strong and persistent rise in equity prices.” Given where stock prices were in 2009, one is tempted to answer, “And?”

But beyond that, Thornton overlooks what stocks did in the 1990s, long before QE and zero bound. Today’s stock market (which anyway has been flat for the last year, and not “persistently rising”) is far more sober than that of 1999, when the average Nasdaq p-e was at 100x earnings, and the S&P 500 at 44.2x earnings. The fed funds rate in August 1999 was 5.25%, and no QE.  The p-e’s on Wall Street today are slightly above long-term averages (now about 20 times earnings), even while corporate profits are at all-time record highs, absolutely and relatively. (QE evidently only has bad unintended consequences; Thornton does not say that QE caused corporate profits to soar to the moon.)

  1. Thornton also complains that QE-zero bound causes a “marked change in the behavior of commodity prices.” Well, one has to smile at this one. There were no commodity boom-busts before QE? BTW, gold hit $887.50 an ounce in 1980, before hitting $273.00 in 2000. Oil has been everywhere and done everything since the 1970s. I think what Thornton wants more than anything is to say, “higher commodity prices signal too-easy money.” That has been the standard refrain from the Theomonetarists since the 1970s, when the U.S. had double-digit inflation and OPEC was jacking up oil prices. In ensuing decades, we had the Chinese industrialization and full-throttle demand for all industrial commodities, while the U.S. ethanol program boosted corn prices, a basic agriculture good (they feed corn to pigs and cows, btw). Global oil was controlled by uncertain thug states. The last three decades have been a great run for commodities, and for inflation-hysterics who could endlessly siren about commodities prices.

But since QE started in 2009, commodity prices have been zooming—downhill. Copper has been cut in half, and gold is way off. Oil is cut in half too, and still going down. Thornton is reduced to saying QE results in a “marked change” in commodities prices. Yes, a “marked” reduction, so far.  Frankly, there are global markets for commodities, and global supply. The Fed went to QE and a nominally low federal funds rate, and commodities prices subsequently tanked. What is the connection?

  1. Thornton credits a “resurgence in house prices and residential construction beyond what is warranted by economic fundamentals” to QE and low interest rates.

Here Thornton seems unaware the basic facts. Housing starts are in the toilet.

BC Thornton

Actually, based on demographics, the U.S. has been under-building housing for years. As for house prices, noose-tight city zoning regulations prevent much new housing stock, and that plays a key role in national housing costs. Does Thornton mean to say U.S. apartments rents are rising (as they are), as there is too much residential construction? How does that work? The unfortunate truth is that even a merely mediocre economy in much of the U.S. will result in higher housing costs. It is a gigantic structural impediment. The solution to rising housing costs is much more liberal city zoning, or even no zoning. Thornton’s solution, on contrast, is to suffocate the economy enough that we obtain house price stability, despite regional housing shortages. Good luck with that—it is called 2008.

  1. Then we have Thornton’s assertion the Fed has caused “excessive risk-taking.” This reprises the “Fed as Mommy” role. You see, in free markets investors and business managers go bananas when interest rates are low. The free-market system is an inherently unstable platform on straw-like stilts, one that collapses whenever investors and business managers are not kept in check by an ever-vigilant Fed. Anyway, American corporations are actually sitting on huge piles of cash and not taking risks. There is not enough demand to warrant expansionist behavior by those who produce goods and services.
  2. I could go on, but another oddity is Thornton’s contention the Fed is too long in hugging the zero-bound tree. Yet, most economists would say the Fed cannot control long-term rates—that is, institutional investors will lend on 10-year Treasuries and other sovereign debt based on their gimlet-eyed assessments of yields, present value and the long-run economic landscape, not Fed antics. Okay, so the 10-year Treasury rate today, set by institutional investors, is 2% and pennies. If I quizzed a college class, “If in Free-Market Utopia Nation the 10-year sovereign-bonds sell at 2.00%, then what would you say the overnight federal funds rate should be?” I would answer, “Really, really low, as low as a morsel of snow.” That may explain why I did not get into Harvard, but the real answer would seem to be “somewhere near zero.”
  3. “Income was redistributed away from people on fixed incomes and toward better-off investors, “ avers Thornton, a reprise of the “Fed is bashing Grandma” argument. One wonders how to respond at less than encyclopedic length to this assertion. Interest rates have been falling globally for decades, and are negative now in many nations, including the famously tight Switzerland. Low rates are a sign that money has been tight, as Milton Friedman said. Monetary policy must be made for the general good, not any particular group or region. Raising rates hurts investors of all stripes—including those who risk equity to start businesses or invest in real estate. In fact, the Fed must be callous about poor people invested only in short-term risk-free assets. Helping the poor is the job of government and charity, not central bankers.
  4. Thornton adds, the “huge increase in the monetary base that QE entailed could cause inflation if the Fed loses control of excess bank reserves.” Again, one must suppress a smile here. Since 1980, has the tight-money crowd ever written a monetary paper that did not warn of the perils of pending inflation, due to Fed laxity? We have lived through five of the last zero hyperinflations, about 23 runaway inflations, and 71 double-digit inflations. Oddly, after decades of wanton laxity by our central bank, we are now paying the price—core PCE inflation is drifting down towards 1%, or perhaps lower if the Fed induces another recession.

In many regards, I have not been fair to Thornton in this brief blog. Thornton does ponder why the Fed is paying interest on excess reserves, thus suffocating some of QE’s stimulus effect. Thornton also criticizes the Fed for not expanding its balance sheet pre-2008, in the early days of failures by financial institutions.

Conclusion

As I have said before, the tight-money crowd has been increasingly erratic since 2009, and the failure for inflation to erupt following QE, or for there to be any detectable consequences for the Fed’s balance sheet (other than taxpayer relief, and some stimulus), let alone catastrophic results. The Theomonetarists are reduced to flying their tattered, sun-bleached storm flags for inflation (as does Thornton), and attributing all present-day economic ills to QE or low interest rates.

In fact, the Fed is too tight. We see weak demand, but global supply lines are thick and unused. We see that PCE core inflation is sinking below even the Fed’s niggardly 2% target. We see unit labor costs nearly dead-flat for years on end, a rising dollar, up 20% in last 18 months.

The Fed should target a robust growth rate via nominal GDP level targeting, and heavily use all tools at its disposal to get there, including QE and even negative interest rates.

15 thoughts on “Zombie Economics Will Never Die

  1. The only way to kill a zombie is to cut off it’s head. Sack Yellen and replace her with someone with econo-political credentials who will do the right thing, not want the zombie, inflation-phobic, economics profession thinks is safe – someone like Greenspan, with little or no academic credentials. Can’t think of anyone though. What about bringing in Kocherlakota to head the Fed? Wikipedia says he is only 52, so could be there for 20 years.

  2. James-

    Unfortunately, a global central bank culture has emerged in the last 30 years, about when central banks won their “independence.” There are exceptions; see Kuroda at the Bank of Japan. Possibly the People’s Bank of China.

    Yellen replaced Bernanke, and adopted his policies 100%. Both were academics with track records suggesting they would not succumb to Fed culture. But they did.

    My suggestion is to place the Fed into the Department of Treasury, and that monetary policy be made by the U.S. President. If voters felt inflation was too high, they could vote on it. If they felt the economy was sickly they could vote on it. The Reaganauts suggested placing the Fed into the Treasury Department, and they may have been right.

    There is also something anti-democratic about the asking the public to decipher why an economy is crappy, when you have an independent Fed in action. A Fed can suffocate an economy, and the sitting President gets the blame (this somewhat happened to George Bush, yes I know, could not have happened to a nicer guy).

    The Fed brought us Obama. and may bring us Trump!

  3. Agreed. Monetary policy is far too important to be left to a bunch of unelected technocratic bureaucrats, no matter what their “credentials”. Scott Sumner’s “elite monetary economist” idea is attractive but failing in practice. Are they really failing because they can’t break free of the non-“elite monetary economists” on the FOMC as Sumner divined from Bernanke’s memoirs? Sounded more like buck-passing to me.

    • @James Alexander, Ben Cole
      Yellen is such politician, she barely passed Senate approval (she was the FED chair with least votes in the senate in history). And remember that she was approved with Democratic party votes, because she was labeled as a “dove” back then. Governors at the FED are appointed by politicians, and approved by politicians.

      What we need are better tools. You guys are doing a great job calling attention to the fact inflation targeting has a much better alternative, and that what matters for AD stabilization is monetary policy, guided by what is going on with NGDP growth. Over time, good ideas like this will sink in…

      • Mr. Robazzi: We need regime change at central banks. Without that, even if central bankers do accept nominal GDP targeting, they will still choose a monetary noose, or a low target.

    • Philo: the word “niggardly” has nothing to do with the racial slur. I love everybody… except possibly central bankers!

  4. Benjamin, this is not a fair post, for all kinds of reasons, but mainly because many of the criticisms you offer are quite unrelated to the claims actually made in Thornton’s paper.

    For example, when Thornton claims that QE may have resulted in some unsustainable asset price developments, you observe that there were booms and busts before QE–as if Thornton’s statement amounted to a denial of that fact!

    When addressing Thornton claims that QE has unduly influenced the behavior of commodity prices, you criticize, not what he actually says, but what you “think he wants to say.”

    You assume that the fact that corporate profits have been “soaring” somehow contradicts Thornton’s concerns about equity prices being excessively high. (Certainly it is now evident that such profits are no guarantee against a major correction.)

    You treat the fact that housing starts are still below their level during the last boom as clear proof that Thornton is crazy to imagine that QE has provided excessive stimulus to the housing industry–as if forgetting about all the overbuilding that the last boom entailed.

    But most of all, you are too intent on attacking “right wing inflation hawks,” and so, instead of addressing Thornton’s actual arguments about the origins and consequences of QE, you make him stand-in for your favorite bête noire, and then criticize the bête noire.

  5. QE Revisited
    On December 20, 2015, Marcus Nunes posted a commentary on my “Requiem for QE,” (Cato Institute Policy Analysis, No. 783, November 17, 2015) suggesting that my analysis of QE is so wrong he didn’t know where to start. In his words, “Wrong is everywhere. But let’s just hack away” (italics added). And “hack away” is exactly what he did. He makes seven points which I will respond to in detail, considering each in turn. Nunes’ first four points are a reaction to my statement that
    If the Fed distorted asset prices between June and December 2003 (as Don Kohn said at the March 2004 FOMC meeting), one can only imagine what the FOMC’s zero-interest-rate policy over the period December 2008 to the present has done. And, of course, Kohn is correct: the intention of the policy is to distort asset prices in an attempt to reduce long-term yields. But such actions produce unintended distortions: a strong and persistent rise in equity prices, a marked change in the behavior of commodity prices, a resurgence in house prices and residential construction beyond what is warranted by economic fundamentals, and excessive risk taking, even by those who are least well situated to take it (p.25).
    On my claim that QE produced a strong and persistent rise in equity prices, Nunes’ states that “Thornton overlooks what stocks did in the 1990s, long before QE and zero bound.” He appears to be implying that I somehow suggested ONLY QE and the FOMC’s zero interest rate policy could cause a “strong and persistent” rise in equity prices. He goes on to note that in 1999 ‘the average Nasdaq p-e was at 100x earnings, and the S&P 500 at 44.2x earnings” when the funds rate was 5.25%. He appears to have forgotten about the Dot.com bubble. While his logic may be lacking, his prose is not short on hacking. Apparently, and unbeknown to me, I said that QE and the zero interest rate policy are the only things that can cause strong and persistent increases in equity prices. I am sorry, but I just don’t remember saying that.
    He then says, “Thornton also complains that QE-zero bound causes a ‘marked change in the behavior of commodity prices.’…There were no commodity boom-busts before QE? BTW, gold hit $887.50 an ounce in 1980, before hitting $273.00 in 2000.” Again, apparently I said that QE and the FOMC’s zero interest rate policy are the only things that can cause asset price booms. But I don’t remember saying that. Indeed, I didn’t say that at all. I said that in distorting assets prices it generated a change in the behavior of commodity prices, which I documented elsewhere (“Is the FOMC’s Policy Inflating Assets Prices,” Federal Reserve Bank of St. Louis Economic Synopses, No. 18, 2011, which can be found at http://www.dlthornton.com by clicking on the student/teacher tab).
    He then questions my assertion that the policy has created a resurgence in house prices and residential construction beyond what is warranted by economic fundamentals. He shows a graph of housing starts, saying “Housing starts and in the toilet,” and asserts that, “based on demographics, the U.S. has been under-building housing for years.” He then asks, “Does Thornton mean to say U.S. apartments rents are rising (as they are), as there is too much residential construction? How does that work?” Well, it works this way: We had lax regulations, excessively low shorter-term interest rates that many home loans were tied to, and an ill-advised, and not carefully thought through, national priority motivated by politics and not economics. This priority allowed people who shouldn’t have had a home to purchase one. When the bubble burst, those people began renting. As demand for apartments increased, so too did rents and construction rental housing. This is basic economics.
    As for Nunes’ point about anemic housing starts, he apparently is unaware that the bursting of the housing bubble resulted in a massive overhang of residential housing, which was a consequence of homeownership going from nearly 70% back down to 65%. It is hardly surprising that construction has been slow and that construction labor took the biggest hit and has been the slowest to recover. Indeed, the overhang of residential and commercial real estate guaranteed that the recession was going to be worse and more prolonged than most of the post-war recessions. Classical economists diagnosed this situation years ago, noting the difference between flow dis-equilibriums and stock/flow dis-equilibriums. The 2001 recession is a classic example of the former; the 2007-2009 recession a classic example of the latter.
    Nunes then takes on my assertion that the FOCM’s policy caused “excessive risk-taking,” saying “The free-market system is an inherently unstable platform on straw-like stilts, one that collapses whenever investors and business managers are not kept in check by an ever-vigilant Fed.” Wow, that came out of left field! How does promoted excessive risk-taking by many who are in the worst position to take risks translate into “the free-market system is an inherently unstable platform.” This is a classic non sequitur! Indeed, my analysis of March 2009 FOMC transcripts strongly suggests that the lack of faith in the economy’s self-healing power led the FOMC to pursue QE and its persistent low interest rate policy (see “The Fed’s Lack of Appreciation for the Healing Power of Markets,” Alt-M, Cato Institute, January 26, 2016, http://www.alt-m.org/2016/01/25/the-feds-lack-of-appreciation-for-the-healing-power-of-markets/ ) Nunes’ analysis of the current problem is the classic Keynesian one, “There is not enough demand to warrant expansionist behavior by those who produce goods and services.” The solution is simple. Just increase demand. But I thought that is what the FOMC’s interest rate policy is supposed to do. What happened? Oh, wait. I think I know. The Fed should have been more aggressive.
    Nunes then takes on my argument that the FOMC has maintained its low interest rate policy too long:
    another oddity is Thornton’s contention the Fed is too long in hugging the zero-bound tree. Yet, most economists would say the Fed cannot control long-term rates—that is, institutional investors will lend on 10-year Treasuries and other sovereign debt based on their gimlet-eyed assessments of yields, present value and the long-run economic landscape, not Fed antics. Okay, so the 10-year Treasury rate today, set by institutional investors, is 2% and pennies. If I quizzed a college class, “If in Free-Market Utopia Nation the 10-year sovereign-bonds sell at 2.00%, then what would you say the overnight federal funds rate should be?” I would answer, “Really, really low, as low as a morsel of snow.” That may explain why I did not get into Harvard, but the real answer would seem to be “somewhere near zero.”
    Clever prose, but short on research. Unlike Nunes, I investigated the effects of the FOMC’s switch to using the federal funds rate as its policy instrument and the effect of this switch during periods when it reduced the funds rate targets to then historical low levels prior to the 2007-2009 recession (“Greenspan’s Conundrum and the Fed’s Ability to Affect Long-Term Yields,” unpublished manuscript, October 2015, which can be found at http://www.dlthornton.com by clicking on the research tab). I found that the two periods when the FOMC reduced its funds rate target to uncharacteristically low levels (1992-1995, and 2003-2005) appeared to have had no effect on the 10-year Treasury yield, but had a noticeable effect on Treasury yields with maturities up to 3 years: In the case of the second period, on the 5-year Treasury yield. Hence, it is not a stretch to think that the FOMC’s current policy had even a larger distortionary effect. Indeed, the behavior of Treasury spreads since 2008 is entirely consistent with my previously analysis.
    Nunes’ critique is also short on logic. Arguing that the FOMC’s policy has distorted yields across the term structure does not imply that longer-term yields are not also influenced by economic fundamentals. Indeed, I used the idea that long-term yields are strongly influenced by fundamentals in the afore mentioned research. I am quite certain that the world-wide economic woes have been a significant factor keeping long-term rates low recently. Moreover, if Nunes believes that the FOMC’s policy had no effect on longer-term yields, he should be asking why did they do it? Moreover, why did Bernanke, Yellen and others say this was the objective? Are they crazy? Why did they engage in “forward guidance,” and “twist” (the term extension program)? They said these programs were intended to reduce longer-term yields. Nunes should have written blogs telling them that such efforts were pointless.
    Nunes then takes on my statement that the FOMC’s policy redistributed income from those on fixed incomes to better-off investors, saying “One wonders how to respond at less than encyclopedic length to this assertion.” Wow, I must have really screwed up this time! I must have because he even says Milton Friedman says I’m wrong: “Low rates are a sign that money has been tight, as Milton Friedman said.” Well, I am not sure I remember Friedman saying exactly that. He did correctly chastise the Burns’ Fed for confusing high nominal interest rates with “tight” monetary policy, that is, by confusing high nominal interest rates with high real interest rates. Indeed, in his presidential address the American Economic Association in 1968 Friedman showed how nominal interest rate targeting could lead to ever accelerating inflation (which, of course, the U.S. experienced in the late 1970s and early 1980s, until the Volcker Fed brought it to an end). In another paper, Friedman argued that the optimal rate of inflation was deflation; specifically, an inflation rate equal to the negative of the real interest rate (which was determined solely by economic fundamentals and independent of monetary policy). Hence, if the real rate was say 2% the optimal rate of inflation would be -2%, and the nominal rate would be zero. So there is a sense in which Nunes’ Friedman-statement might be considered correct. But, of course, the FOMC has now embraced a 2% inflation objective. If the FOMC’s QE/zero interest rate policy has not affected interest rates, as Nunes’ and others now contend, the nominal interest rate should be somewhere in the neighborhood of 4%.
    Nunes sums up by saying “Monetary policy must be made for the general good, not any particular group or region. Raising rates hurts investors of all stripes—including those who risk equity to start businesses or invest in real estate. In fact, the Fed must be callous about poor people invested only in short-term risk-free assets. Helping the poor is the job of government and charity, not central bankers.” Now I am sympathic to view that monetary policy is a blunt instrument that should promote general welfare. Indeed, I hope we can all agree that it does this by keeping inflation low. Nevertheless, Nunes’ logic so far seems faulty. The problem is insufficient demand. If the FOMC’s policy cannot affect long-term rates, which nearly all macroeconomists see as being most important for affecting spending, it cannot have had an important effect on spending. He appears to concede that low rates have reduced the incomes and, therefore, consumption of those who are on fixed incomes. But since the FOMC didn’t do this anyway—low interest rates were not caused by the FOMC’s policy—it is not responsible. So why the statement that the Fed needs to be callous? It’s not responsible for these things! Moreover, over why do Bernanke, Yellen and a host of other economists and analysts believe that the FOMC’s actions on interest rates spared us from a second depression?
    Finally (yes, we have come to the end, but only because Nunes ran out of energy, for it appears I said little in my 27-page analysis that was useful or correct), Nunes takes on my statement that the “huge increase in the monetary base that QE entailed could cause inflation if the Fed loses control of excess bank reserves.” This time his critique was overpowering: “Since 1980, has the tight-money crowd ever written a monetary paper that did not warn of the perils of pending inflation, due to Fed laxity?” That is, we have been warned about the impending inflation that has yet to arrive. Again, his critique is long on prose, but short on analysis. He might ask himself why the Fed opted to pay interest on excess reserves and not only required reserves—Friedman’s and others recommended paying interest on required reserves to reduce or eliminate the implicit “reserve tax” on banks. He should also ask himself why the Fed didn’t make the interest rate -25 basis points instead of +25 basis points. If the objective was to increase spending a negative interest rate would have given banks a great incentive to make loans rather than accumulate idle deposit balances (which are currently about $2.4 billion) with the Fed. It is arguably the case that this would have had a much larger effect on spending than the FOMC’s QE/zero federal funds rate policy. He might also ask why Bernanke (2012) said
    With monetary policy being so accommodative now, though, it is not unreasonable to ask whether we are sowing the seeds of future inflation…the Fed can tighten policy [read raise the federal funds rate], even if our balance sheet remains large, by increasing the interest rate we pay banks on reserve balances they deposit at the Fed. Because banks will not lend at rates lower than what they can earn at the Fed, such an action should serve to raise rates and tighten credit conditions more generally, preventing any tendency toward overheating in the economy.
    I said little more than Bernanke did, so we must both be wrong. If the Fed loses control over excess reserves the result will be a higher rate of inflation. The difference between me and Bernanke is I am less confident that the Fed will be able to do so and have said why (“A Perspective on Possible Fed Exit Strategies,” Federal Reserve Bank of St. Louis Economic Synopses, No. 21, 2013, which can be found at http://www.dlthornton.com by clicking on the student/teacher tab).
    Too sum up. Nunes’ blog is long on prose, but short on research, logic, and economics. Nunes did conclude his “hacking” by saying “In many regards, I have not been fair to Thornton in this brief blog. Thornton does ponder why the Fed is paying interest on excess reserves, thus suffocating some of QE’s stimulus effect. Thornton also criticizes the Fed for not expanding its balance sheet pre-2008, in the early days of failures by financial institutions.” Whew! It appears I may have gotten something right. But I am mystified that he did not connect the statement about paying interest on reserves with the inflation potential of QE.

  6. Daniel Thornton: Thanks for reading and then responding to my post. Your comment is very thorough and thoughtful. Before you commented, I answered George Selgin’s comment in a fresh post, and that new post somewhat responds to your comments as wll.

    My short answer is that we disagree, and the longer answer is, “So what, let’s have a beer, some chips and turkey, and watch the Super Bowl.”

    I will pose this: Thornton, you say, “With monetary policy being so accommodative now, though, it is not unreasonable to ask whether we are sowing the seeds of future inflation….”

    If monetary policy is so accommodative, please explain what is happening to the US dollar, now trading much higher against trade-weighted mixed baskets than before QE….up 25% from recent lows…

    And why is the market predicting inflation on the PCE at 1% for the next five to 10 years?

    I would say it is more likely is that present monetary policy (and other structural impediments, including property zoning, occupational licensing, a $1-trillion-a-year national security complex, taxes on productive citizens and welfare for unproductive citizens, and one and on) is bringing on another recession, or Japanitis.

    This is accommodative? What would “tight” look like?

  7. Well, no models of exchange rates work well. The sorry fact is that we can’t predict exchange rates and we have no consistent explanation for them. Meese and Rogoff (1983) pointed this out some time ago and little has changed since.

    Sadly, the same now appears to be true for inflation. The standard Keynesian PC model does very badly despite the fact that its proponents keep changing it in a vain attempt to make it work. The same is true for the Monetarists money growth model, which only appears to work well using very low frequency data. Nevertheless, I believe that few economists doubt that very large increases in the money supply–such as what could occur if the enormous amount of excess reserves held by banks (currently about $2.4 trillion) were suddenly become required reserves– would not cause a marked increase in the inflation rate. The truth is that the profession does not have an inflation model that works well in the short- or intermediate-terms.

    I agree that monetary policy is not the only thing holding back economic growth. Other structural problems, including those you mention, are to blame. But keeping the funds rate ridiculously low and the Fed’s portfolio massively bloated won’t make things better and will, very likely, make things worse.
    Dan Thornton

  8. Dan: Okay, good comments.

    But consider Japan. They have been at zero for more than a generation, and are running QE now. Where is the inflation?

    Additionally, I contend an economy cannot have “immaculate inflation.” In a globalized economy, it is very hard to generate demand-pull inflation. As I have pointed out in other posts, there has been no inflation in new auto prices in 20 years, and it is a global industry and one with 25% excess capacity even now, after a pretty good year for sales.

    So, to get to inflation, first we have to create demand in excess of capacity—yet we have global supply lines and global capacity for many markets. Maybe all markets—one can hire an architect now in Milan, thanks to the web. Call centers in India.

    U.S. housing markets are constrained due to ubiquitous property zoning, and the famed NIMBY, which applies to every neighborhood in the US, regardless of political perspective. Ask them in GOP-centric Newport Beach CA why they do not have condo towers lying the coast. The solution here is impossible, thanks to a 1926 Supreme Court ruling that gave local government to right to zone land. We should just endure some inflation in housing markets.

    Moderate inflation is a positive anyway. Life is not perfect, but economic prosperity is good!

    Today the bogeyman is stagnation, not inflation.

    I pick Panthers in Super Bowl, now that my heroes, the Pats, went down.

    • Well, we are just going to have to disagree. The link of inflation to excess money creation is strong, but empirically weak in the short and intermediate run in developed economies, but strong in the long run. The link between inflation and “demand in excess of capacity” (something that we cannot even measure) is weak empirically and theoretically weak (note I didn’t say none existent) since aggregate supply does not exist in any meaningful sense; nor does aggregate demand for that matter. See “Does Aggregate Supply Exist: Should We Care” at http://dlthornton.com/index.php/services

  9. Pingback: George Selgin And Me – NGDP Advisers

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