Scott Sumner  

Immaculate inflation and immaculate growth

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Here's Paul Krugman:

Barry Ritholtz reminds us that we've just passed the third anniversary of the debasement-and-inflation letter -- the one in which a who's who of right-wing econopundits warned that quantitative easing would have dire consequences. As Ritholtz notes, they were utterly wrong. Also, rereading the letter now, you have to wonder what kind of economic model they had in mind. They asserted that
The planned asset purchases risk currency debasement and inflation, and we do not think they will achieve the Fed's objective of promoting employment.
So they'd be inflationary without being expansionary? How was that supposed to work? There were a few actual economists in the group; do they subscribe to the doctrine of immaculate inflation?
Fair enough. But why don't Keynesian economists, especially British Keynesian economists, see that their faith in fiscal stimulus under an inflation targeting regime is essentially equivalent to the doctrine of immaculate growth? Somehow fiscal stimulus was supposed to boost RGDP growth in a country with 3% inflation, without leading to any increase in the rate of inflation.

A vertical SRAS curve and a flat SRAS curve are two equally false hypotheses.


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COMMENTS (7 to date)
Edgar writes:

Scott,

Thanks for the references I requested in a comment to a previous post.

I'd like to know your explanation of why the prediction of high inflation as a result of QE was wrong. And please add your explanation of why QE has not led to a much larger increase in NGDP.

Data from FedStLouis show
MONETARY BASE INCREASE 2013 (3Q)-2009 (1Q) just over 100%,
NGDP INCREASE less than 20%, and PRICE INCREASE around 7%.

Scott Sumner writes:

Edgar, It was wrong for many reasons. Start with the technical explanations:

1. The demand for base money soared because market interest rates fell to near zero, and also because the Fed pays interest on reserves. Both factors encourage people and banks to hold larger cash balances.

Then there is the deeper policy explanation:

2. The Fed has adopted the "Taylor principle" of raising rates by more than inflation expectations rise. This policy has credibility, and hence markets don't expect high inflation. That makes the Fed's job much easier--as the markets adjust the demand for base money in such a way as to keep inflation relatively low.

Andrew_FL writes:

@Scott Sumner-

The Fed has adopted the "Taylor principle" of raising rates by more than inflation expectations rise.

Taylor himself has been pretty adamant that they are definitely not doing what his rule would tell them to do. And haven't been, for that matter, for several years now.

Edgar writes:

Scott,

Thanks. Have you ever heard of a 100% increase in the monetary base (yes, I know it took over four years to double the base) that has not had a large effect on nominal variables, starting with all price indexes (say a simultaneous increase of at least 50%)?

Rob Rawlings writes:

"But why don't Keynesian economists, especially British Keynesian economists, see that their faith in fiscal stimulus under an inflation targeting regime is essentially equivalent to the doctrine of immaculate growth?"

I'm not s Keynesian but surely you would just have to believe that fiscal policy could boost RGDP relative to NGDP more than monetary policy alone could ?

For example monetary policy alone delivers 5% NGDP growth and 2% inflation. Fiscal policy (aided by monetary policy) gets 7% RGDP growth before hitting 2% inflation because some of new money comes via direct spending on capital projects.

Michael Byrnes writes:

Edgar:

I think the key is that this expansion of the base is largely expected to be temporary.

Imagine you check your bank balances one day and find that your balance has increased by 100%... or even 100-fold. There is a nice little note from the bank saying that they would like you to spend more so they have jacked up your balance. However, the fine print says that although this money will remain in your account indefinately, the bank reserves the right to withdraw some or even all of it in the event that they decide you are spending too much money. Oh, and if they decide to remove more money than you have, you are liable for the difference.

Would you go on a hog-wild spending spree? I'm guessing no, unless it ends with you residing in a ne country with a new identity.

By and large, people expect the Fed to be more or less on the ball when it comes time to remove all of this excess liquidity from the system before it does any inflationary damage. (If enough people expected otherwise, prices would already be rising).

If the Fed had been more willing to declare that some of the base expansion was going to be permanent, they could have gotten more bang for their QE buck. (Just as a permanent gift of $1,000 would change your spending patterns more than a temorary "gift" of $100,000.)

lxdr1f7 writes:

"Somehow fiscal stimulus was supposed to boost RGDP growth in a country with 3% inflation, without leading to any increase in the rate of inflation.

A vertical SRAS curve and a flat SRAS curve are two equally false hypotheses."

Slack labor markets and excess capacity allow for growth without inflation or very limited inflation as a result of monetary debasement.

The SRAS curve is curved its not a perfect straight line. Initially its flat or almost flat and further along to the right it begins to slope upwards more as you draw down on the slack in labor markets and other things like excess capacity.

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