A Plea to New Keynesian Economists
Gavyn Davies, writing in the FT on the dreadful UK GDP data says: “Many economists are arguing that monetary policy is running out of options and that the one remaining hope is to delay the path for fiscal tightening”
This must be the most depressing comment I’ve read in a particularly depressing week.
Can “many economists” please go and re-read Svensson, Bernanke, and Krugman? Because the idea that monetary policy will “run out of options” at the ZLB is exactly the opposite of what those guys concluded a decade or more ago.
Paul Krugman advised setting a higher inflation target. Fine. Simple. We can do that. It takes a single letter from HM Treasury to Threadneedle Street to achieve that. It requires one stamp, not a Budget through Parliament and a thousand civil servants working out how to efficiently allocate capital, and not a penny on the national debt.
(And incidentally, this is the Paul Krugman of 2012 in one of his less partisan moments: “Fiscal policy might be great. But if you’re not getting it you should be doing something on the Fed side and I think that logic becomes stronger and stronger as the years go by. And it’s sad to see that the Fed has largely washed its hands of responsibility for getting us out of the slump.”)
Ben Bernanke deployed the killer argument that it must be true that central banks can always print money and devalue their currency, boosting domestic inflation:
…[One] can apply a reductio ad absurdum argument, based on my earlier observation that money issuance must affect prices, else printing money will create infinite purchasing
power. Suppose the Bank of Japan prints yen and uses them to acquire foreign assets. If the yen did not depreciate as a result, and if there were no reciprocal demand for Japanese goods or assets (which would drive up domestic prices), what in principle would prevent the BOJ from acquiring infinite quantities of foreign assets, leaving foreigners nothing to hold but idle yen balances? Obviously this will not happen in equilibrium.
And Lars Svensson has a “Foolproof Way” to exit the ZLB, using a price level target. Note that word, foolproof. That means even Osborne can’t screw it up. I see no reason why the Bank of England could not deploy a price level target within their existing mandate.
So why, oh why, oh why, have “most economists” decided that monetary policy is “running out of options”, when even the New Keynesian academics who researched monetary policy at the ZLB gave us a plethora of options? “Self-induced paralysis” is exactly right.