Paul Krugman: Immaculate Inflation Strikes Again

Am I wrong to be appalled at how there are too many economists whose knowledge of models carries with it negative knowledge about the economy? I always thought that technique was to be in the service of understanding, not a substitute for it. Yet whenever I look at a David Andolfatto claiming that there is no relationship between unemployment and inflation or a Robert Lucas claiming that private decisions fueled by increasing money balances to spend affect production and prices but public decisions do not… or Eugene Fama and John Cochrane trying to resurrect Say’s Law 190 years after it had been abandoned by Jean-Baptiste Say… I am, to say the least, not impressed at all: Paul Krugman: Immaculate Inflation Strikes Again: “We’re currently well above historical estimates of full employment, and inflation remains subdued. Could unemployment fall to 3.5% without accelerating inflation? Honestly, we don’t know…

…I would also argue that the Fed is making a mistake by tightening now…. We really don’t know how low U can go…. The costs of getting it wrong are asymmetric…. Finally, there are very good reasons to believe that the Fed’s 2 percent inflation target is too low; certainly the belief that it was high enough to make the zero lower bound irrelevant has been massively falsified by experience.

But should we drop the whole notion that unemployment has anything to do with inflation? Via FTAlphaville, I see that David Andolfatto is at it again…. Even if you think that inflation is fundamentally a monetary phenomenon (which you shouldn’t, as I’ll explain in a minute), wage- and price-setters don’t care about money demand; they care about their own ability or lack thereof to charge more, which has to–has to–involve the amount of slack in the economy. As Karl Smith pointed out a decade ago, the doctrine of immaculate inflation, in which money translates directly into inflation–a doctrine that was invoked to predict inflationary consequences from Fed easing despite a depressed economy–makes no sense. And the claim that there’s weak or no evidence of a link between unemployment and inflation is sustainable only if you insist on restricting yourself to recent U.S. data. Take a longer and broader view, and the evidence is obvious….

Economics is about what people do, and stories about macrobehavior should always include an explanation of the micromotives that make people change what they do. This isn’t the same thing as saying that we must have “microfoundations” in the sense that everyone is maximizing; often people don’t, and a lot of sensible economics involves just accepting some limits to maximization. But incentives and motives are still key. And it’s ironic that macroeconomists who are deeply committed to the microfoundations project–or, as Trump might say, the “failing microfoundations project”–also seem to be especially likely, perhaps due to their addiction to mathiness, to forget this essential rule…

May 7, 2018


Brad DeLong
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