A Question for Richard Koo: Daily Focus
Conference on European Economic Integration (CEEI)
Re: http://www.oenb.at/dms/oenb/Publikationen/Volkswirtschaft/CEEI/2014/koo_ppp/Koo_PPP.pdf
I am not sure that I can ask this question coherently. So if I do not, please feel free to just say “that was not coherent” and move on to answering the coherent questions…
The conventional arguments of those whom Martin Wolf calls the Austerians runs more-or-less like this: someday QE will succeed in shifting beliefs from an expectation of permanent depression to an expectation of rapid normalization. Savers then look at their holdings of maturing government bonds and roll them over only if they are offered a normal and positive real interest rate. And then the price level will rise very rapidly to a value at which–as John Maynard Keynes said of France during its inflation of the 1920s–real future government primary surpluses discounted at the normal real interest rate are equal to the nominal debt divided by the price level.
In your framework, that would be a sudden very large shift in private-sector net savings behavior from surplus to deficit. And in your framework such a shift is almost inconceivable. But in their framework such a shift seems almost inevitable. Can you tell me why judgments of likelihood of a near-hyperinflationary collapse upon normalization are so different in the two frameworks? I know that 25 years of history strongly suggest that they are wrong, but why? It was, after all, right for France in the 1920s. It was possibly right for peripheral European countries trapped in the eurozone. It was right for Argentina. Why is it not right–or not possible for any reasonable probability–for reserve currency-issuing credible sovereigns?
Koo slides:
UPDATE: perhaps the real issue is that we have three underlying models of macroeconomics. The first is the quantity theory of money MV = PY: the stock of money times its velocity equals the price level times production. The second is the Wicksellian savings investment equation S = I + (G-T): savings either finances investment or is absorbed by the government deficit. The third is the fiscal theory of the price level D/P = PV(-dp,r): the real stock of debt–the nominal debt divided by the price level–is equal to the present value of future primary surpluses discounted at the real interest rate. All three of these must be true at the same time, which means that at any time two of them are likely to be nearly redundant. For those two, shifts in what are supposed to be their driving variables are neutralized by countervailing forces. Right now, for example, increases in the money stock are offset one-for-one by reductions in velocity, and increases in the nominal debt are offset one-for-one by higher future primary surpluses and reductions in future real interest rates.
From this perspective, the key question of macroeconomics is always: when do each of these three models have primary traction, and why? Richard Koo just said that the state of the economy shifts like the flick of a switch: Enter a balance-sheet recession in which firms are engaged in minimizing debt, and it is S = I + (G-T) and the impact of balance sheets on S and I that governs the state of the economy. Leave–flick the switch–and the quantity theory of money holds for a near-constant velocity, with small shifts in the quantity of money driving adjustments that make the Wicksellian S = I + (G-T) hold.
But when do you enter and when do you leave depression–or balance-sheet–economics, with Wicksell’s equation the driver and the other two more-or-less passive adjusters? When do you enter and when you leave monetarist economics? And when do you enter and when do you leave the quasi-hyperinflationary economics that is the fiscal theory of the price level?
Until I figure this out, I am going to have a hard time teaching this stuff. Until I figure this out, I’m going to have a hard time even thinking about this stuff.