Department of “WTF?!” Chris House on Traditional Macroeconomic Models and the Great Recession
Can anyone put forward a credible explanation for this?
Chris House (July 13, 2014): Traditional Macroeconomic Models and the Great Recession: “Commentators like Paul Krugman…
…should also own up to the mounting evidence that the older models (even the paleo-Keynesian models that some prefer) clearly failed…. They made clear predictions about inflation that were supposedly at the center of the New Keynesian mechanism–predictions that never materialized.
Paul Krugman (April 13, 2013): The Missing Deflation: “Keynesians…. One area where things haven’t worked out as [we] expected…
…however, is on the deflation front. Inflation has stayed very subdued; but coming in to the crisis I certainly thought that actual Japanese-style deflation was a real possibility. That hasn’t materialized (and for that matter, even Japan never had more than very gradual deflation). Why?
One possibility was that there wasn’t as much slack in the economy as we thought, that a lot of the problem was structural rather than cyclical.
Another possibility, however, which I at least noted fairly early on, was that downward nominal wage rigidity could explain why the fairly rapid falls in inflation seen in previous slumps weren’t happening this time; if wages are “reluctant” to actually fall, inflation becomes “sticky” at low levels even with a very depressed economy.
So now we have two new analyses, by Hobijn and Daly at a Boston Fed conference, and in the IMF’s new World Economic Outlook, both of which strongly suggest that the issue isn’t structural unemployment, it’s low responsiveness of inflation to unemployment when inflation is low to begin with.
Three points here:
This does say that there is little risk of accelerating inflation. Indeed, Hobijn and Daly suggest that there’s a “pent-up demand for wage cuts” that will probably push inflation lower even if the economy is recovering.
Central banks and other policy makers will be making a terrible mistake if they look at low, stable inflation and pat themselves on the back for a job well done. Low, stable inflation, it turns out, is entirely consistent with catastrophic economic mismanagement.
Notice how Keynesians responded to the partial failure of a prediction: by asking what they got wrong, and how their model of the world needed to be adjusted. This, of course, shows what fools we are: everyone on the other side of these debates knows that you respond to mistakes by never acknowledging them, and doubling down on whatever you originally claimed.