Evening Must-Read: Paul Krugman: Changing Circumstances, Monetary Policy, and Fiscal Policy
Paul Krugman: Changing Circumstances: “You can pretty clearly see three things:
- Until 2008, the Fed leaned against the wind, raising rates when inflation was high or unemployment low.
- After 2008, the Fed would have liked to cut rates but couldn’t.
- Also after 2008, as a result of the zero constraint, monetary policy no longer leaned against the wind.
Point 3 strongly suggests that you would expect different results from many kinds of economic policies, such as cutting unemployment benefits. Now, there are a couple of points that will predictably come up here. Some people will argue that the Fed coulda and shoulda and maybe even did make up for its inability to lower short-term rates with other policies. My view would be that making monetary policy truly effective at zero rates, if it was possible at all, would have required more radical action than the Fed was willing or politically able to take.
Also, some people will notice that the current inflation/unemployment mix is close to the point where a line sketched through the blue points hits the zero axis. Is the liquidity trap over? My answer is that the unemployment rate is looking less and less useful as a gauge of labor market slack, and its recent decline isn’t telling us much about monetary policy. But controversies aside, I like this picture as a way of seeing how regimes change when the economy is very depressed.