Monday, June 12, 2017

Maybe more links will solve the problem


I thought it was a mistake: three links to stuff about the insufficiency of 2% inflation:


Not a mistake. Apparently, Thoma likes what DeLong and Kocherlakota have to say.


The first link -- Rethink 2% -- is a copy of a letter to the Fed, signed by Kocherlakota and DeLong and Mark Thoma and a bunch of other economists with lots of name recognition. The letter opens with an uninspiring account of our economic troubles:

The end of this year will mark ten years since the beginning of the Great Recession. This recession and the slow recovery that followed was extraordinarily damaging to the livelihoods and financial security of tens of millions of American households. Accordingly, it should provoke a serious reappraisal of the key parameters governing macroeconomic policy.

One of these key parameters is the rate of inflation targeted by the Federal Reserve...

They open with the ten-year complaint? Why would anyone read on, unless to criticize it in a blog post? (Note, for example, that "This recession and the slow recovery" are two things, not one thing; so maybe the letter should say This recession and the slow recovery were damaging rather than "was" damaging. Where is Paul Romer when you need him?) The second paragraph continues:

In years past, a 2 percent inflation target seemed to give ample leverage with which the Fed could lower real interest rates. But given the evidence that the equilibrium interest rate had fallen substantially even prior to the financial crisis, and that the Fed’s short-term policy rate remained at zero for seven years without sparking any large acceleration of aggregate demand growth, a reassessment of this target seems warranted...

So their concern is that two percent no longer provides enough room for rates to fall, should the need arise. And that the "equilibrium" rate has fallen, and that two percent inflation has not solved the problem.

The second paragraph concludes with a call for "moderately higher" inflation.

My problem with the views expressed in the letter is that inflation is not a solution to economic problems. Higher inflation may change the shape of the problem, from one acceptable to the 1% to one acceptable to the 99%, but it does not solve the problem.

You might say that a problem 99% of the people can live with is better than a problem 1% of the people can live with. Okay, but it's still a problem: It's not a solution. Anyway, the 1% of the people have 99% of the money, so they can put things back in their favor easily. We'll get higher inflation for a while, and then we won't, and the problem will remain.

Note that the letter considers it a "given" that the equilibrium rate has fallen. This is unacceptable. According to the letter, the fall in the equilibrium rate appears to be an integral part of the problem. If that's the case, you don't accept it as a "given" and turn to moderately higher inflation as a coping mechanism. No. You investigate the fall in the equilibrium rate. You look at its causes rather than its consequences. And then you explore solutions that might reverse the causes of the fall of that rate.

And that's just for starters. You have to trace the problem to its origin. It is not enough to find the proximate cause of the problem. It is never enough to find the proximate cause.


Mark Thoma's second link is The Fed Needs a Better Inflation Target by former Fed bank president Narayana Kocherlakota.

Kocherlakota opens with a reference to the "Rethink 2%" letter:

Today, a group of economists published a letter urging the U.S. Federal Reserve to consider a monumental change in policy: raising its target for inflation above the current 2 percent.

I signed the letter. Here's why...
His explanation sounds very much like the opening of the letter itself, with its concern about having room for interest rates to fall:

The inflation target helps define how much stimulus the Fed can deliver when it lowers interest rates to zero...

Same page. But Kocherlakota spends the rest of the paragraph explaining his thinking, which is the worst thing a writer can do. He does get in a couple of decent hyphenated terms, but explanations are always dreary. And then Kocherlakota ends the paragraph by explaining that three percent is "a full percentage point" more than two percent. Reminds me of the "six is greater than one" TV commercial.

Kocherlakota writes:

The issue is all the more important because periods of zero nominal rates are likely to be more frequent.

More frequent than in the past.

Why? Because of "a lowering of the 'natural' interest rate consistent with full employment and stable inflation". You know:

the equilibrium interest rate had fallen substantially even prior to the financial crisis
The "given". Again.

So, the same story from two sources. But prob'ly not two sources. Prob'ly one source with two outlets, to make it seem like many people had the same thought independently.

Anyway, Kocherlakota says that the fall of the equilibrium rate

might require the Fed to be at the zero lower bound about 30 percent to 40 percent of the time.

So don't you think we might want to figure out what caused the equilibrium rate to fall, and reverse the causation, and get that rate back up again? But no: Like the letter, Kocherlakota says we should cope with the problem by raising the inflation target.

Kocherlakota again:

Of course, there's also a case against raising the inflation target. That’s why the more important part of the letter is its call for “a diverse and representative commission” to re-examine the monetary policy framework -- a much more open and transparent approach than the Fed usually takes. When the policy-making Federal Open Market Committee (of which I was a member) chose the 2 percent inflation target in January 2012, its deliberations were completely hidden from the public. As a result, the target has little buy-in from the public and Congress.

Bullshit. The 2% target has "little buy-in" because it didn't work.


Mark Thoma's third link is Why the Fed Should Rethink Its 2%/Year No-Lookback Inflation Target by Brad DeLong.

Oh! I thought it was going to be "same pile, different foot" again; but maybe not. DeLong says his contribution to the discussion was "to set out what the arguments on the other side are—and why we do not find them convincing".

Well, good. I'm not "on the other side", but I don't favor raising the interest rate target as a solution to anything, because it isn't a solution to anything. So, maybe DeLong will address my concerns and educate me. We'll see.

DeLong says he sees four "other side" arguments, all of which are wrong. I'll just look at the first one:

"Even at the zero lower bound," the Fed has other tools, and does not need to raise the inflation target. That argument is wrong, DeLong says, because the other tools have not worked. His evidence is the low employment and low production of the past decade.

Okay, but that doesn't mean that raising the inflation target will solve the problem. I'm willing to admit that a sufficiently high inflation rate would probably boost spending and employment and production. But I'm not willing to admit that the low levels of those things are the problem. Oh, sure, they are a problem for people. But you don't fix the economy by fixing people's problems. You fix the economy by fixing the economy's problems. When the economy is working right, people's problems get fixed more or less automatically.

Since the time of Carter and Volcker and Reagan, many things have been done to the economy to "fix" things. Bringing the inflation rate down was only one of those things. Where is DeLong's call for a reversal of all the other things? Why does he only want to reverse the lowering of the inflation rate?

The impediment then was the same as it is today: Economists and policy-makers look at outcomes and try to improve them. What they need to do is look at outcomes and correctly determine the causes of those outcomes. Then maybe they'll have to look upon those causes as if they were outcomes, and chase down their causes. And when they discover the causes, maybe they'll have to do it again. They have to track the problem to its source.

They don't do that. They didn't do it in the Carter/Volcker/Reagan era, and they're not doing it now. As I said, a higher rate of inflation could boost employment and production without solving the problem that made employment and production go low.

No one is saying the problem is that prices are too low. A higher rate of inflation would fix that problem -- but that isn't the problem.

1 comment:

The Arthurian said...

Three iterations of causation:

1. Low employment and low production, caused by excessive private debt.

2. Excessive private debt, caused by the policy that encourages it.

3. Policy that encourages private debt, caused by the flawed mindset of policymakers.

It will be convenient if you reject my view at the first iteration, for then you never arrive at the third iteration, where your error is exposed.