At What Time Scale, If Any, Does the Long Run Come?

Paul Krugman: Is The Economy Self-Correcting?: “Brad DeLong… has this wrong…

…The proposition of a long-run tendency toward full employment isn’t a primitive axiom in IS-LM. It’s derived… under certain assumptions… [with] good reason to believe that even under ‘normal’ conditions it’s… very weak…. And under liquidity-trap conditions it’s not a process we expect to see operate at all….

Blanchard, Cerutti and Summers… find… a half-life for output gaps of around 6 years. [In] the long run… we might not all be dead, but most of us will be hitting mandatory retirement…. [And] at the zero lower bound the process doesn’t work… [but] bring[s] on a debt-deflation spiral. Yes, a sufficiently large price fall could bring about expectations of future inflation–but that’s not the droid we’re looking for mechanism we’re talking about here…. Slumps usually don’t last all that long… [because] central banks… push back…. The economy isn’t self-correcting… [but] relies on Uncle Alan, or Uncle Ben, or Aunt Janet to get back to full employment. Which brings us back to the liquidity trap, in which the central bank loses most if not all of its traction…

But, I say, Uncle Ben did try to come to the rescue!:

• A doubling of the monetary base…
• Followed by the 20% increase in the monetary base that was QE I…
• Followed by the 30% increase in the monetary base that was QE II…
• Followed by the 50% increase in the monetary base that was QE III…

These are big increases. If you think that only 1/10 of quantitative easing will permanently stick, that’s a 36% rise in the long-run money stock and thus the long-run price level. If you think that only 1/25 of quantitative easing will permanently stick, that’s a 15% increase in the long-run price level.

It is true that some of us thought that Uncle Ben should go double again after QE III–that he should push the monetary base up from $4 trillion to $8 trillion to see what happens. But Ben’s decision to call a halt to base-expansion was not clearly wrong, given the limited benefits and the unknown unknowns associated with such derangement of the structure of asset duration, after a 360% increase in the monetary base.

Paul will say that this is what his “in the liquidity trap… the central bank loses most if not all of its traction…” means. And Paul Krugman is (surprise! surprise!) right. To lose that much traction, however? To have the default assumption be that none of quantitative easing is going to stick for the long run, whenever the long run comes?

The failure of the full-employment long run to come “soon” once extraordinary quantitative easing was on the policy menu may not have surprised Paul. It certainly has surprised me…