I was looking up the precise definition of liquidationism in order to avoid throwing around a term and sounding ignorant about it when I found this entry from April 2009 on Greg Mankiw’s blog where he addresses criticism from Bob Murphy regarding his solution of negative interest rates.
Here’s Bob Murphy as quoted in Greg’s blog post:
Let’s stipulate for the sake of argument that the “equilibrium real interest rate” is negative, and that the nominal interest rate goes all the way down to zero. But oh no! Given the current array of prices and the expected array of prices next year, the implied real interest rate is too high for the market to clear. What to do?
Mankiw’s suggestion is that the Fed should credibly promise to dump gobs of new dollars into the economy in twelve months, thus raising the future price “level” and giving people an incentive to unload their dollars today, while they have some purchasing power.
But there is another alternative, and that is for market prices today to fall very steeply until the market clears. The short-term collapse in prices during the present month, say, will then allow for rapid price inflation back up to “normal” prices a year from now. [Emphasis in the original.]
Here’s Greg’s Response:
I think this analysis is correct, under the maintained assumption that prices (including wages) are completely and instantaneously flexible. But if prices are sticky, then the immediate deflation and concurrent increase in expected inflation won’t occur painlessly. Instead, it would take a while for the price level to fall, and as we wait, the economy would suffer through a period of depressed economic activity…
I wish we lived in the world that Mr. Murphy describes, but my reading of the evidence is that we don’t.
Don’t ask me why I got this as hit when searching for liquidationism, but I think that if we consider the plan that Mr. Murphy laid out and how the Fed has provided a very light touch over the last few years, I wonder if he has any explanation for his prediction being not quite so accurate. Perhaps it has something to do with the Sumner critique and the 2% ceiling on the PCE? Just a hunch.
Even more to the point, however, we had the rapid collapse in prices in the autumn of 2008 with very little intervention from the Fed ($200B in QE1 to avoid deflation and should have sped the market clearing up by a little bit). It doesn’t seem to have panned out with core PCE averaging 1.1% for the last 46 months, but we did get some headline inflation in groceries and transportation fuel by the spring of 2010 that many on his side blamed on the Fed. And here we are in 2012 with unemployment stuck above 8% and going in the wrong direction over the last quarter, and many prices and wages not going anywhere at all; so much for “rapid price inflation back up to “normal” prices a year from now” as a result of natural price adjustment and market clearing.