Should-Read: Robert Waldmann: A Comment on the Return of “It’s Baaaack”

Should-Read: Very sharp from Robert Waldmann on many things, one of them the difference between “credible” in a game-theoretic sense and “credited” in an economic-actor sense—and on the smoking ruin left of macroeconomics for a generation by economists who devoted their careers to fuzzing the distinction. And Ima gonna start using “it is a relephant” for “it is irrelevant” all the time. Just saying: Robert Waldmann: A Comment on the Return of “It’s Baaaack”: “Twenty years ago, Paul Krugman warned that the liquidity trap was not just an issue in the economic history of the 30s…

… Extremely excellent and very much worth reading…. [A] claim was that if the price level fell enough, the real value of money holdings (real balances) would be a significant part of wealth and this would cause high consumption (this is called the Pigou effect)…. Krugman notes that formal math says if real balances are huge because of a liquidity trap, people know that their apparent wealth will be consumed by inflation tax (or by taxes needed to retire money if the monetary authority doesn’t accept inflation)….

My first point… is actually Larry Summers’s point. In 1998, Krugman assumed that Japan would, sooner or later, exit the liquidity trap…. 20 years later, it seems that the trap might be permanent. This would invalidate Krugman’s argument that… a credible (that is credited — believed) promise to cause high inflation when the economy is out of the liquidity trap will be effective. What if this is a promise about policy on the 8th of never?…

…I claim a second problem is the abuse of “credible” which is used to mean “sincerely and honestly asserted” and “believed by others, that is credited”. The rational expectations assumption sneaks in and asserts that if people should believe, then they will believe. It makes private agents beliefs seem to be part of the policy…. Non-standard monetary policy works by changing expectations, and it is assumed policy makers can do that (or rather the implications of the assumption are studied by people who regularly warn that they don’t know if this will happen & say therefore fiscal stimulus should be used). There is also an equivocation in “regime shift” which is used to refer to a major permanent change in policy and the belief that a change in policy is major and permanent. With the equivocal definitions, unconventional monetary policy can’t fail, it can only be failed.

And (finally) I get to the bit of Krugman’s post with which I disagree. He assesses the effects of unconventional policy (as proposed by Krugman) and says the evidence is mixed. I actually became almost known as a skeptic of unconventional monetary policy and I think the evidence strongly suggests it doesn’t work…. The regime shift (if any) was Kuroda’s promise to do whatever it took to get to 2%. From November 2916 to November 2017 (the most recent 12 month period on FRED) Japanese consumer prices increased 0.5%. I conclude that it can’t be done (I don’t think anyone could use the communications channel much more vigorously that Kuroda)….

The evidence of monetary regime shifts (as the phrase is used which includes the assumption that people believe the policy has changed and that this matters a lot) is, I think, reduced to countries going off the gold standard in the 1930s. I’m going to focus on 1933 and not just FDR (YOU KNOW WHO else went off the gold standard in 1933?). Here in two big cases there were other “regime shifts”: either a major partisan realignment or, uh, you know, a literal regime shift.

I now have returned to thinking that “credibly promising to be irresponsible” that is “achieving a monetery policy regime shift” can’t be done (which doesn’t mean it isn’t worth trying if the economy is in a liquidity trap and fiscal policy makers are austerian)…


Brad DeLong


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