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James Bullard on Neo-Fisherian economics

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James Bullard has a Powerpoint presentation on NeoFisherian economics. It concludes with 8 bullet points; here is the first:

Policymaker conventional wisdom and NK theory both suggest low nominal rates should cause inflation to rise.
Is this actually what they believe? I have mixed feelings. On the one hand IS/LM certainly doesn't say that low interest rates will lead to higher inflation, rather it says that low interest rates caused by a rightward shift in the LM curve (i.e. easy money) will raise inflation. But on the other hand Bullard is certainly correct that both monetary policymakers and New Keynesians economists often talk as if low rates lead to higher inflation. I'm not sure if they really believe that, or if they are just temporarily "reasoning from a price change".

In contrast, the Neo-Fisherian view is that low interest rates lead to lower inflation. This view is also an example of reasoning from a price change, and hence is also false. Low rates lead to low inflation only if the low rates are caused by a leftward shift in the IS curve.

The market monetarist view is that easy money leads to higher inflation, and easy money sometimes lowers interest rates and sometimes raises them. Any reductions in interest rates tend to occur in the short run, whereas higher interest rates tend to result in the long run. In addition, it's more useful to think in terms of causation as going from inflation to interest rates, rather than interest rates to inflation. (The one exception is if you hold the money supply and the IOR rate constant, in which case lower rates are deflationary.)

The simple empirical evidence reviewed here suggests this is not happening even after 6.5 years of ZIRP.
That's right, and that's why the conventional view is wrong.
Even if the Fed begins normalization this year, U.S. and other rates will still be exceptionally low over the medium term.

These very low rates may be pulling inflation and inflation expectations lower via the neo-Fisherian mechanism.


That seems extremely unlikely, given that the markets respond to news of a surprise Fed rate increase in a way that suggests the market views this policy as disinflationary.

For now, I am willing to argue that current inflation is low in part due to temporary commodity price movements, and that inflation expectations remain well anchored.

If the neo-Fisherian effect is strong in the quarters and years ahead, however, we will need to think about monetary policy in alternative ways.


But how would we know if the "neo-Fisherian effect is strong in the quarters and years ahead"? What evidence would we look for? Certainly not a correlation between inflation and interest rates, that's also a prediction of the Market Monetarist model, which relies on the old-fashioned Fisher effect. Instead, we'd want to see evidence that markets interpret unexpected Fed rate increases as inflationary and rate decreases as deflationary.

Don't hold your breath waiting for such evidence.

PS. I travel to England this weekend, to the Warwick Economics Summit, so blogging will be light.


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COMMENTS (5 to date)
bill writes:

It's so hard to take this Neo-Fisherian view seriously. Looking even just at the latest 25 bps rate increase, I wonder if the Neo-Fisherians think the 10 year Treasury at 1.87% is a sign of coming inflation?

Jeff writes:
It's so hard to take this Neo-Fisherian view seriously.

Don't bother. It's clearly ridiculous. An equilibrium concept with no idea of how you get to the equilibrium, and no idea of how you stay there once you arrive, is meaningless.

I went to grad school in the mid-80's, but even with the rational expectations revolution already the new conventional wisdom, we still had to learn the old comparative statics stuff that was 40 years old even then.

Nobody back in those days would have dared present a model with an equilibrium without also presenting some stability analysis. Everyone knew what a knife-edge equilibrium was and why it was worthless for explaining how the real world worked.

We seem to have forgotten an awful lot of basic macro in the last few years.

ThomasH writes:

I do not think very many people are unaware of how much lives of even the poorest are better than the poor before the Industrial Revolution. That awareness I'd argue has very little to do with whether any particular "reform" involving additional taxes is good or bad.

Given that we are hugely better of than our ancestors what is the optimal carbon tax? What is the best sort of government intervention in the medical insurance-health care market? How should cities charge for the use of streets and roads? How progressive should a consumption tax be? How much should the federal government invest in different kinds of research. I do not see that a proper appreciation of the differences in pc income now and 300 years ago gets us very close to an answer to any of these.

However wonderful you think capitalism is does not mean that it cannot be improved.

Scott Sumner writes:

Bill and Jeff, Good points.

Thomas, That was probably intended for the next post?

Benjamin Cole writes:

Gee, maybe inflation is low as the Fed has had a monetary noose around the neck of the economy for a long time. You see the US dollar exchange rate? Any clues there?

Long-term interest rates are low for long time, because like Milton Friedman said: A sign monetary policy has been tight and for a long time.

But central bankers generally agree on what is the right monetary policy: Always and everywhere it should be tighter.

And central bankers everywhere agree they should be independent.

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