A very interesting post. Here is one excerpt:
Mike’s enthusiasm for deliberate inflation is even more puzzling to me. Mike uses the word “stimulus,” never differentiating between real and nominal stimulus. Surely, we don’t want to cook up some inflation just for its own sake — we want to cook up some inflation because we think it will goose output. But why? Why especially will increasing expected inflation help? Because that is the aim of all the policies under discussion here — promising to keep rates low even once inflation rises, adopting “nominal GDP targets,” helicopter drops, or similar policies such as raising the inflation target.
I don’t put much faith in Phillips curves to start with — the idea that deliberate inflation raises output. I put less faith in the idea floating around Jackson hole that a little inflation will set us permanently back on the trend line, not just be a little sugar rush and then back to sclerosis.
But nobody has a Phillips curve in which raising expected inflation is a good thing. It just gives you more inflation, with if anything less output and employment. Read Mike’s book!
Woodford is, and was, a neo-Wicksellian. He obviously thinks that the economically important long risky bond rates are too low. He says as much when he talks about how QE has been less effective than desired, though without developing the point much. But Cochrane dismisses that outright using 10 yr. Treasury rates (which one can argue are more like money, globally speaking, than bonds) and then indulges in some self-indulgent speculation on Philips curves.
Why is there such bad parsing of thought all around. This is massively infuriating. Over at Sumner’s blog everyone’s convinced themselves that Woodford believes in omnipotence theory of central banking. Now Cochrane is convincing himself that Woodford believes in a Philips curve that his own book contradicts.
And everyone admits freely how they have no patience to go through the entire paper. 4 years ago when Buiter presented his massive paper, everyone kept harping on about his rating of central banks. Hardly anyone spoke about what was truly insightful in his paper – the bit about a central bank being a market maker of last resort. And everyone admitted freely then that they no patience either.
Tyler, let us know your own thoughts about Woodford’s paper. I’m sure you’ll do a much more comprehensive and insightful job than the people you’re linking to.
Sorry, I meant long rates are too *high*. Cochrane’s reading is of course more detailed than the market monetarist reading. But he still doesn’t get under the Wicksell-Keynes-Tobin analytical framework underlying Woodford’s paper.
Nobu Kiyotaki would get it, and would also be acceptable and convincing to Fama/Cochrane/Williamson.
Cochrane states, “So the case for “stimulus” must be that some other, unstated lack of “demand” is the problem, and that all “demand” is the same so that monetary “stimulus” will cure that problem. I disagree on that one.”
How does he square this with repeated surveys of business both big and small state that demand is the one thing that is lacking out there and that we have repeated historical cases that stimulus can address this one. It’s weird that a number of economic indicators are creeping upward including private sector employment. The one big gap that drove a hole in the economy was the massive layoffs at the state and local levels which have not bounced back and probably will not unless states raise the necessary revenues to hire people (though even there, reports of greater tax receipts at the state level are also encouraging). If Cochrane has a plan to increase demand and thus spur the economy, I sure would like to see it.
The Schadenfreude part of me would like to see a Romney win in November just to see what these geniuses will do. However, I then think about all the socially repressive things that they will spend time on and I think that it’s better to keep these folks holed up in their offices and writing op-ed pieces for the WSJ and the National Review (though one hopes that their arithmetic improves).
“How does he square this with repeated surveys of business both big and small state that demand is the one thing that is lacking out there and that we have repeated historical cases that stimulus can address this one.”
The first part of your query is easy: Public Choice Theory.
For the second part on “repeated historical cases,” I’d invite you to review Tyler’s earlier post this morning on China.
Real vs. nominal demand, as Cochrane explained…
So if I get this right, there’s little the Fed can do which I think is correct because they cannot legislate solutions but must work from a restricted set of tools (it’s like trying to repair a car engine with just a hammer and a vise grip). My point (echoed by Bill McBride here: http://www.calculatedriskblog.com/2012/09/gdp-and-employment-drag-from-state-and.html?utm_source=feedburner&utm_medium=feed&utm_campaign=Feed%3A+CalculatedRisk+%28Calculated+Risk%29) is that demand is demand and nobody is going to expand a business if there isn’t any. As long as we have the divided government things are just going to muddle along but at least we can take comfort that we are not as bad off as Great Britain who continue to believe that austerity works.
“that we are not as bad off as Great Britain who continue to believe that austerity works”
Please stop propagating the falsehood that GB had anything even remotely representing austerity.
I’d bet all businesses would always say “people aren’t buying enough of our stuff.” It’s what they do for a living. Now, if you compare boom to trough, surely you’d get differences. But it’s about like surveying a patient about their disease. They are going to say they feel bad. They don’t necessarily know why or what will be effective treatment and what the side-effects will be.
Businesses think they have capacity to produce IF customers had the money. “Assume a bunch of money…” So, the only way more money won’t produce inflation is if there really is capacity EVERYWHERE. But then why would there be a recession? There certainly must be a bottleneck somewhere and I assume it is the price control on liabilities. So, you are hoping for inflation and you are hoping that it goes directly to reducing the real cost of debt. Oh, and it still will create inflation and jack with prices because money supply isn’t neutral. So, you are assuming inflation is neutral with a strategy dependent on it not being neutral (you hope liabilities don’t increase with the inflation). So, add the uncertainty of how the inflation will filter through as an additional cost to offset with the speculative benefits.
None of this is anti-inflation. But if you have a single ounce of “planning is important and planning requires SOMETHING being constant” then I think you should be very afraid.
And btw Romney isn’t an anti-Obama in anything meaningful. He’s just the stuffy white buttoned-up version. He’s Obama without the beer, stigs, sweet jump hook, and smooth IPod playlist.
So real government spending per capita did not fall in the UK? I really doubt this.
Mr. “Hyperinflation is coming in 2010″ just has a lot of sour grapes. Thats all. Looks like corporations are doing fine to me: http://research.stlouisfed.org/fred2/series/CP
I feel like Cochrane is assuming the conclusion quite a bit in that piece.
I think he is assuming that everyone will have read or be familiar with Robert Lucas.
A few reactions to his post…
1. No one (really no one) knows how households and firms form and adapt their inflation expectations in normal times let alone when a monetary policy regime shifts. People believed the Volcker Fed. They didn’t have to.
2. Everyone agrees that the economy is not operating at its full productive potential. Lots of stories about why and to what extent, but everyone sees some cyclical problems.
3. What to do about it depends mainly on your politics/economic beliefs. No silver bullets or cure alls. (Plus medicine usually has adverse side effects.) Seems to me that people’s views on policy going forward split on whether sins of omission are more worrisome to them than sins of commission.
Thought-provoking paper that has generated a lot thoughtful blog commentary.
I think inflation would improve the housing market by reducing the real value of mortgage debts. Hopefully that would help the economy.
inflation = homeowner led balance sheet recovery? this thought has flitted through my mind as well.
This is the mechanism that I argued before. However, this only works if it doesn’t lead to an increase in borrowing.
It only works for monetary caused inflation, and only sometimes.
Can’t this can work even with a modest increase in borrowing? People with healthy balance sheets can borrow and spend more, goosing consumption, while people with unhealthy balance sheets continue to repair their fiscal position.
But nobody has a Phillips curve in which raising expected inflation is a good thing. It just gives you more inflation, with if anything less output and employment. Read Mike’s book!
This is just an embarrassingly uninformed statement by Cochrane. What the hell was he thinking? Raising expected inflation is a good thing in practically every liquidity trap model.
Maybe he’s thinking of the New Keynesian Phillips Curve (or any other Phillips Curve), where you have pi_t = beta*E[pi_{t+1}] + kappa*x_t, where x_t is the output gap. Holding pi_t constant, raising expected inflation means that x_t must go down. But, of course, the entire point is that pi_t is not constant!
One subtle point in Woodford’s paper and other work, by the way, is that overcoming the zero lower bound isn’t all about creating expected inflation. Instead, the main goal is to lower forward rates by committing to holding rates low for longer than you otherwise would. This involves committing to tolerate higher inflation than otherwise, and that inflation can bring down ex-ante real rates and help you even further, but it doesn’t mean that the inflation is itself the only mechanism at work; in fact, it’s often not the most important mechanism.
But anyway… again, what the hell is Cochrane thinking? The implication (“read Mike’s book”) is that Woodford doesn’t understand the most basic properties of his own models. That is indeed true of some economists (*ahem* Cochrane), but Woodford is one of the most careful, technically sound and intelligent macro guys around. There is no f-ing way that he misunderstands the basic principles behind Philips curves; what’s actually going on is that Cochrane has a hackish understanding of this material, but is so characteristically brimming with overconfidence that he assumes his misunderstandings must actually be someone else’s mistake.
There is one, and only one, test that enough is being done, and that is inflation. Nothing else they do amounts to a hill of beans.
Regardless of the predictions of various models, we would need to have more inflation in order for the market price of short term bonds to be able to clear. Wouldn’t that clearly be worth something?
4% isn’t enough for you?
Apparently, it’s not enough for the market, since bonds with less than a few years’ maturity are basically hitting a price ceiling.
Well… The fed is holding interest rates down. (as has been pointed out repeatedly)
Well, they should create some inflation so rates go up.
The low interest rates indicate deflation???
No. They indicate a very negative real interest rate, so that the nominal interest rate is still below zero, even with moderate inflation.
If SRAS is not vertical, doesn’t increased NGDP (nominal output) imply some increased output? If the Fed is able to move the needle on nominal income, doesn’t that imply it has the ability to fractionally real output, too, at least until we get much closer to the economy’s capacity and the curve steepens?
I think Bill Woolsey nails it in the comments of that post.
Bill Woolsey:
“Woodford clearly claims that an expected increase in nominal GDP growth in the future, whether it is due to higher inflation or higher real output, will raise spending on output now, and either result in higher current real output or higher inflation.
The statement that Woodford agrees with you that it can have no effect on spending now is false.
Also, if you think that the “phillips curve” is that higher inflation causes lower unemployment, then it is no surprise you are confused. The actual argument is that higher spending on output leads to higher inflation and higher output growth and higher output growth leads to higher employment growth and lower unemployment. Given the growth rate of spending on output, the more of it that is inflation, the less of it is real output growth and the higher will be unemployment.
In other words, adverse aggregate supply shocks lead to higher inflation and higher unemployment and that includes an expecational shock of higher inflation.”
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