Convergence to the Long-Run Macroeconomic Omega Point and Inflation Targeting: Nick Rowe’s View

Convergence to the Long-Run Macroeconomic Omega Point and Inflation Targeting: Nick Rowe’s View

Nick Rowe enters what I am starting to call: The Omega Point Discussion:

Nick Rowe: Back propagation induction does not work under inflation targeting: “Suppose you lived in a world where, whenever the price level fell/rose by 1%…

the central bank responded by decreasing/increasing the base money stock by the same 1%. A world like that would not have a long-run Omega point, from which some present equilibrium can be pinned down by back propagation induction.

That’s the sort of world we live in, under the inflation targeting regime. A drunk doing a random walk does not have a destination, from which we can infer his route by working backwards. His long run variance is infinite.

Stop arguing about whether a market macroeconomy is or is not inherently ultimately self-equilibrating. It’s a stupid question. It depends. It depends on the monetary regime.

Instead, let’s solve the stupid question by adopting a nominal level path target.

I commented:

Touché…

You do realize that only me, David Glasner, and a few other people will understand this? That it needs to be unpacked at considerably greater length if you want it to have reach?

Yours,

Brad DeLong

Actually, however, Nick Rowe is not quite right. An adverse nominal demand shock not only cuts prices but also raises unemployment and reduces capacity utilization. Those put downward pressure on future inflation. The cut in prices leads an inflation-targeting central bank to proportionally cut the money stock, yes. But the reduction in forecast future inflation leads the central bank to then give back some of that money-stock reduction.

Thus: convergence to the Omega Point is not eliminated. It is, however, attenuated. The arrival of the economy at a state within shouting distance of the Omega Point is not pushed off to the infinite future. It is, however, pushed off to the more distant future. And convergence is certainly much slower than under monetary policy rules with more reasonable nominal monetary anchors in them.

But all this is, or ought to be, part of a much broader discussion about how long it is before the long run arrives, and whether back-propagation induction-unraveling is an important mechanism in the world or, rather, only an “as if” metaphor of some sort. That broader discussion should be, I now think, in three parts:

  • Waiting for the Long Run
  • What Happens in the Short Run
  • Is Back-Propagation Induction-Unraveling Really a Thing?

June 4, 2015

Connect with us!

Explore the Equitable Growth network of experts around the country and get answers to today's most pressing questions!

Get in Touch