Friday, January 1, 2010

Sumner's Response

One of the several things I really like about Scott Sumner's blog (now at a new address) is that he takes the time to respond to every comment. So far I can claim to have done so also ... but only because I have no comments. Feel free to be the first anytime.

Anyway, I sent him a question which he said it would probably take him days to get to. His answer is up the next day. While he has me largely convinced that tight monetary policy is largely responsible for the current mess we're in, I've been trying to figure out how, even if the Fed announced they were going to follow him lockstep and raise NGDP/inflation expectations, how does this then translate into cure? Tyler Cowen at MR argued that there are some structural problems in the economy right now and we can't inflate our way out of those. I asked him for his response to that and my lingering concern. The short of his response:
Would reversing this nominal shock be able to reverse all the negative effects I described?  I can’t say for sure.  We have structural problems like extended unemployment benefits that we didn’t have in mid-2008.  But I still think it would do a lot of good.  More NGDP could help because asset prices are highly volatile and forward-looking, while nominal wage rates are very sticky.  A strong increase in 2011 NGDP expectations would sharply raise asset prices, but hardly budge current nominal wages (given 10% unemployment.)  This would boost employment and output.

Every day that goes by my preferred policy response becomes slightly less effective in reducing the problems we currently face.  But oddly a decision to “be irresponsible,” i.e. to have “excessive” NGDP growth in order to catch up to the 5% trend-line, would make it far less likely that NGDP growth expectations would collapse in the next crisis.  
While I am somewhat skeptical of the pass-through from asset prices to employment, this last part puts Sumner in a remarkable policy camp. Most people are stuck fighting the last war. A few visionaries fight the current one. He's worrying about the next war. Hats off.

He finishes:
This time they collapsed because the markets guessed the Fed would not try to correct its error and return NGDP to the old trend line.  And as each day brings new stories of a Fed itching to tighten policy even as the fiscal authorities are contemplating new stimulus (a policy mix showing our government is approaching  “banana republic” level of incompetence) it becomes more and more evident that the bearish speculators of late 2008 were right—NGDP is going to stay on a new and permanently lower growth track.  There will be no nominal recovery.  And with the lengthened unemployment benefits the real recovery will take longer than normal.

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