Talking past each other?

This post referencing an article by Prof. Delong makes me think people are talking past each other.

Delong and compatriots say that monetary policy has failed and so fiscal policy is necessary. They then mention things about how people are suffering and how we need to alleviate that suffering. They don’t go this far, but at least rhetorically they connect fiscal policy with reducing that suffering, as if its the only way to do so.

Barro et al say monetary policy hasn’t run out of steam and traditional fiscal policy is ineffective. The later point is irrelevant to the economic debate, but key to the policy debate. There are some “untraditional” fiscal policies that would act to improve expectations of inflation. Also rhetorically, at least, these folks are concerned about smoothing out the business cycle.

The thing is smoothing the business cycle and alleviating suffering are the same thing. We all share the same goal! The weird thing is, if you sat everyone around the table, they’d all agree the best way to smooth the business cycle (and alleviate suffering) is to have a constant level of inflation and the best way to do that is to have constant expectations of inflation.

The honest to god dispute is which policies will bring about constant expectations of inflation. Right now traditional monetary policy isn’t workable. The options are non-traditional fiscal stimulus (e.g. “helicopter drops”), quantitative/qualitative easing or both. The policy we’re seeing is traditional fiscal stimulus and tons of qualitative easing.

My take on the stimulus package is that it won’t be very helicopter drop-ish ((and I suspect this fiscal policy may actually slow down recovery by slowing down sectoral shifts, but that’s pure speculation)). Our real hope for recovery is in the untraditional monetary policy being pursued by the Fed. So far, contra-Delong, I think its working given indicators of inflation expectations, though, I’ll admit these measures of expectations are very noisy.

7 thoughts on “Talking past each other?”

  1. “The weird thing is, if you sat everyone around the table, they’d all agree the best way to smooth the business cycle (and alleviate suffering) is to have a constant level of inflation and the best way to do that is to have constant expectations of inflation.”

    I don’t know about them, but it seems obvious to me that inflation is the least important thing about this recession – inflation was pretty much stable all across the world in the runup to this crisis. No, this cycle is all about things like debt, leverage, unsustainable spending, asset prices, financial instruments, overoptimism and pessimism… which is why most macroeconomists, trained to focus solely on inflation, have completely and utterly failed to see this coming.

  2. “things like debt, leverage, unsustainable spending, asset prices, financial instruments, overoptimism and pessimism… why most macroeconomists [] utterly failed to see this coming.”

    Forecasting is a different problem from business cycle policy (i.e. which policy is best for getting us back to full employment). To be honest, macroeconomists, or at least this one, know little about the fluctuations of economy’s natural capacity for production (i.e. the potential production of the economy given the size and quality of the work force and given the installed capital base). We usually assume these fluctuations are random or unpredictable.

    Hopefully, this crisis will tell us something about forecasting (dealing with asset bubbles in particular) but this is sorta tangential to my post… not to mention tangential to the debate on stimulus.

  3. Ooh, good answer. I only asked because I’ve seen different numbers for “full employment” kicked around ranging from zero to about 6% of the population.

  4. There are various estimates and it probably varies over time. I think the estimates are between 5 and 6%.

    This actually makes sense. If there’s some huge innovation, computers or whatever, tons of people will want to quit their jobs and find a new one working with swong. This will increase the natural rate of unemployment. Also, younger folks don’t know what they’re good at and they tend to change jobs a lot. If the population is getting older, I’d expect this to reduce the natural rate.

  5. Usually, when the government announces large new spending packages, the yields on its long-term bonds increase sharply. Why do we think now is any different? In other words, why do we think that the stimulus package has nothing to do with the concomitant rise in the long-term bond yields, and that it’s all monetary policy at play?

    In any event, I guess we’ll know for sure when Friday’s CPI comes out. If it is monetary policy, as you say, then we’ll see a nice little inflationary pop in the CPI. (Which, for non-economist readers, would be a decidedly good sign). If the core CPI is flat or negative, then we’ll finally all be able to agree that the Fed has pretty much shot its load already…

Comments are closed.