I don’t know Mr. Williamson. But the tone of his blog leads me toward an inclination that he isn’t necessarily someone whom I would seek as company as he seems to lack a quality of self-criticism while finding plenty of fault in others. Case in point is this post titled “Teachable Moment,” dated December 1, 2013 where he suggests that De Long, Krugman, and Rowe are confused and doesn’t bother to show what about their claims exhibit confusion. Instead, he goes on to list all of his “models” that supposedly prove his correctness.
Here’s a quote from the first paragraph (Who is “we?”):
Students are often confused, and we can’t always figure out why. The teachable moment comes when students actually articulate their confusion, and then you can work on trying to help them. Nick Rowe, Brad DeLong, and Paul Krugman are all confused – each in his own way – about my last blog post.
Here’s what he has to say about the models:
Let’s start with Krugman, as he’s by far the most articulate of the lot – you can actually understand what he’s complaining about. The basic ideas in my post come from two papers, my recent AER article, and this recent working paper. So, I’m not just writing something in a blog that I thought up in the shower. The models I have been working with are built on a Lagos-Wright base. There are good reasons for that. In particular, including credit, collateral, banking, and other key features of financial markets in this type of environment is relatively straightforward. However, not everyone is familiar with Lagos-Wright, so I took some pains to write up some notes based on cash-in-advance. Why cash-in-advance? I think Krugman understands it, since he is clearly a slavish follower of Bob Lucas, and Paul has used cash-in-advance at least once in a paper.
Krugman should love this, for a number of reasons:
1. The key to solving the inefficiency problem that arises in the model is fiscal policy.
2. The underlying problem is that the fiscal authority is doing something stupid.
3. The economy is non-Ricardian – government debt matters.
4. Monetary policy is non-neutral. Indeed, monetary policy can have effects that persist forever.
5. This is all about financial frictions. During the financial crisis, some people seemed to want to tell macroeconomists they had been barking up the wrong tree by paying insufficient attention to such things.
The first thing that comes to mind from this list is whether the assumptions fit the facts. Here’s what he says about fitting the facts:
In a liquidity trap equilibrium, where the nominal interest rate is zero and open market operations are irrelevant at the margin, if the value of the consolidated government debt is sufficiently low, the inflation rate i is determined by
(1) i = BW – 1,
where W is an inefficiency wedge related to consumption goods – a financial inefficiency wedge – and B is the discount factor. With no financial inefficiency, W = 1. Further, that inefficiency wedge is what is determining the liquidity premium on government debt at the zero lower bound. That is, the low real interest rate is associated with an inflation rate greater than the rate of time preference at the zero lower bound.
Why is this important? Economists have typically associated the zero lower bound with deflation. Thus, once the Fed effectively went to the zero lower bound in late 2008, some people, including Krugman, started to worry about deflation. But the deflation never appeared – indeed, by mid-2011 the inflation rate was running at close to 3% per year. Krugman, faced with a puzzle, argued that wage rigidity explained why inflation was not falling. But you can explain what is going on more satisfactorily, I think, by taking account of the financial inefficiency wedge. At the zero lower bound, as inefficiency increases, the inflation rate rises, and as inefficiency wanes, the inflation rate decreases. Following a financial crisis, it certainly seems useful to explain what is going on in terms of financial factors, and the post-recession path for the inflation rate in the U.S. seems roughly consistent with the story.
This claim seems fudged because he doesn’t say which measured inflation rate he is talking about. Core PCE has averaged 1.2% since the fall of 2008 and the time slice regarding the claim made here is important because prior to the fall of 2008, PCE averaged just above 2%. If we used the GDP deflator, it would make the claim seem absurd.
There are also rounds of QE 1 & 2 missing from the assumptions. Imagine that. Perhaps OMOs aren’t as irrelevant as assumed. So is it a fudgy inefficiency wedge that explains his observation or is something else like QE, or in the event he is being irresponsible by assuming CPI, perhaps a drought or supply issues with commodities that make up the difference?
The only thing being taught in this blog post is that Williamson has holes in his arguments that are large enough to drive a truck through. “We” are not amused.
PS: This guy overwhelms me with grief. I do not understand how someone can be so single-mindedly consumed with headline CPI without questioning the appropriateness of use for purposes of monetary policy. It turns into some rather perverse incentives such as a central banker’s heart-felt relief that a drought has struck the Mid-West, absolving him/her of responsibility for an episode of severe monetary induced disinflation while the financial system implodes and unemployment skyrockets. There isn’t anything brilliant or worthy of admiration in that.
PPS: So what’s up with Williamson’s moniker – New Monetarism? Friedman must be spinning in his grave.