Morning Must-Read: Paul Krugman: The Limits of Purely Monetary Policies

…because I’ve been there…. I had my road-to-Damascus moment… in 1998…. Back in 1998 I… believed that the Bank of Japan could surely end deflation if it really tried. IS-LM said not, but I was sure that if you really worked it through carefully you could show… doubling the monetary base will always raise prices even if you’re at the zero lower bound…. (By the way, I screwed up the aside on fiscal policy. In that model, the multiplier is one.)

To my own surprise, what the model actually said was that when you’re at the zero lower bound, the size of the current money supply does not matter at all…. Doubling the current money supply and all future money supplies will double prices. If the short-term interest rate is currently zero, changing the current money supply without changing future [money] supplies… matters not at all….

As a result, monetary traction is far from obvious. Central banks can change the monetary base now, but can they commit not to undo the expansion in the future, when inflation rises? Not obviously…. But, asks Evans-Pritchard, what if the central bank simply gives households money? Well, that is, as he notes, really fiscal policy…. I’m pretty sure that neither the Fed nor the Bank of England has the legal right to just give money away as opposed to lending it out; if I’m wrong about this, put me down for $10 million, OK?…