Must-Read: Paul Krugman: Anchors Aweigh
Must-Read: The answer, presumably, is the same as it was in the 1960s and 1970s: that “too big” a deviation from the anchored level of inflation for “too long” will de-anchor inflation, for weasel parameters “too big” and “too long”.
It has always seemed to me that if inflation expectations are “well anchored”, then monetary policy is obviously too tight. There are very powerful upsides from a higher-pressure economy. There are no downsides unless inflation expectations are barely-anchored–in which case a higher-pressure economy runs the risk of de-anchoring them, with associated costs. But with well-anchored inflation expectations there is a substantial amount of slack somewhere in the policy-optimization problem. And no professional economist should be happy or comfortable with such an outcome.
: Anchors Away: “Since 2008… demand-side events have been very much what people using IS-LM would have predicted (and did)…
…But on the supply side, not so much…. Model-oriented public officials and research staff at policy institutions… [now] say… they work with… ‘anchored’ expectations… [which] don’t change their expectations in the face of recent experience… like the old, pre-NAIRU Phillips curves people estimated in the 1960s. And… such curves fit pretty well on data since 1990….
Where does anchoring come from and how far can it be trusted? Is it the consequence of central bank credibility, or is it just the consequence of low inflation?… Second… the anchored-expectations hypothesis tells a very different story about capacity and policy…. Let me illustrate this point with the case of the euro area…. Euro core inflation is currently about 1 percent; the slope of the Phillips relationship is around 0.25; so getting back to 2 should require a 4 percentage point fall in unemployment. That’s a lot! How much output growth would this involve?… This naive calculation puts the euro area output gap at 8 percent, which is huge. Should we take this seriously? If not, why not?
http://krugman.blogs.nytimes.com/2015/12/04/anchors-away-slightly-wonkish/