In the past I have been quite dismissive of the claim that easy money is to blame for the financial crisis of 2008. To be sure, the claim that the Fed “kept interest rates too low for too long” so that people gorge on credit regardless of ability to pay en masse doesn’t pass the smell test when contrasted to the problem of tightening during a large negative supply shock and the impact of the subsequent severe disinflation on money contracts, the result of lack of accommodation of excess money demand (a shock in itself) has on nearly everything having to do with markets and the economy, and a complete and persistent disregard for conditions on the ground and human welfare by monetary authorities. The former condition could not ever justify nor necessitate the latter, at least to the degree executed, except perhaps in the eyes of sadomontarists who have an all too holy an alliance with prices and extra-tight money for a good measure of illumination toward financial saintliness.
I have to hand it to David Beckworth who, with his new paper on the end of inflation targeting, almost had me convinced that perhaps there is something to the claim, at least until I started writing this post. In the paper he contrasts two extreme failures of inflation targeting, one having to do with failure to ignore positive productivity shocks that tend to cause a drop in prices in which the central bank would loosen policy by reducing interest rates below the market clearing level to keep inflation on track. That, in turn, causes an excess accumulation of capital and distortion of price signals that would, by and large, serve as a natural stabilizer if left alone; and the other extreme having to do with tightening during a negative supply shock with which I completely agree.
It makes sense. And along with that particular contrast, Beckworth attempts to demonstrate that failure to ignore a positive productivity shock is what lead to the “irrational exuberance,” to borrow a phrase from Greenspan, of the early and mid-portions of the 2000s decade shown in graphs of productivity growth in the US over the course of several decades. It may even be somewhat true. But the argument has, from my prospective, an overall logical problem because the gap in trend NGDP from recessions in 2001 and 2003 wasn’t closed until 2005. And if I might be so bold, it’s the gap that provides context for the stance of policy over time, if we’re to assume that symmetry is what matters. I suppose it might be reasonable to argue that some form of natural adjustment took place between 2001 and 2005 to make the previous NGDP trend irrelevant. But given the time natural healing has taken to partially mitigate the Great Recession, there appears to be a gap in logic there that has yet to be explained considering that NDGP targeting is advocated as a replacement.
It’s not that I disagree with the theme of the paper or conclusion. I have argued very passionately that inflation targeting is a disaster and needs to go. When it goes, however, it needs to be replaced with something. I hate to admit it, but I think of myself as being more anti-inflation-targeting than pro-NGDPLT, being driven in large part by the portion of personal disaster attributable to IT has wrought on my life; a sort of up-close-and-personal radicalization process that can never be undone. The idea of NGDPLT is, thus far, without equal in proposition of satisfaction. It would be livable, in theory, while IT has been proven to not be livable in practice as evidenced by the last six years of varying degrees of financial chaos with the appearance of nobody in charge.
To invert this thought a bit, I am bothered by the adherence of inflationistas everywhere to the price level CPI as if that is the only thing that matters at any given time. I haven’t found any academic research that says that. Additionally, nobody has shown that a 1% inflation rate is superior to any other stable rate however derived. Rao Aiyagari found papers by the inflationistas themselves that don’t prove that. Yet, there are reams of papers that challenge those points, in addition to pointing out logic behind having a higher rate or, in the case of Beckworth (and others), pointing out that IT incentivizes incoherent monetary responses to the totality of macro conditions in real-time. The unhealthy fixation on low inflation, the lower the better, in contrast to the point of having a stable rate or some other nominal anchor is, on the whole, unjustified and painfully so. Thus, I fail to see the problem of letting go of IT, the vacuum-packed Friedman rule, and all the rest of IT-related nonsense that culminate in a logical dead-end from which humanity should be spared.
HT: Lars Christensen