Dumb & Dumber in monetary policy circles

That´s the feeling you get when reading stuff with titles such as:

Central bankers have one job and they don’t know how to do it


How should recessions be fought when interest rates are low?

Further, it seems central bankers are quick to fall prey to an old and discredited theory and think inflation is “always and everywhere a cost phenomenon”.

It is either of the “cost-push” variety, as was popular in the 1960s and 1970s, or of the “cost-pull” variety in vogue today.

The former, through oil producers, oligopolies and unions, was the wisdom behind high/rising inflation. The latter, through globalization, technological advances and demography, the mainstay of inflation remaining persistently below target.

The “solution” to the former type was to implement “incomes policy”, a sophisticated designation for wage & price controls.

The “solution” to today´s “cost-pull” is not yet fully articulated, but appears to require a “greater role for fiscal policy”.

Just as Milton Friedman criticized the “cost-push” view, Market Monetarists criticize today´s “cost-pull” view.

In the late 1990s and early 2000s, there were several conferences and papers on “Monetary Policy in a Low Inflation Environment. All emphasized the danger of interest rates hitting the ZLB…

As the panel below shows very clearly, the “danger” is not “low inflation”, but “too tight” monetary policy, in particular one that allows NGDP growth to tank and even “submerge”. That´s the factor that leads directly to the ZLB

Japan did it first, in the 1990s. The others did it together in 2008. There´s no deflation like in Japan because the US, the UK and the Eurozone all have a positive (around 2%) inflation target. (Japan´s implicit inflation target was zero %!).

In the US, UK and EZ, NGDP growth, after tanking, remains positive, but low and stable. In Japan, it was either zero or negative.

The “victim” of the monetary policy blunder is real growth. The case of the Eurozone makes this clear. As the next chart shows, “Trichet´s folly” caused a second dip in the Eurozone NGDP growth, further lowering the level of real output. Draghi´s actions only sustained the new depressed level of real output.

The effective “solution” is easy to see. Central Banks should lift the level of NGDP and then sustain a stable NGDP growth rate. Nominal stability will return and the ZLB will become once again just a “theoretical curiosity”.


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