Thursday, May 23, 2013

Simon Wren-Lewis — The Liquidity Trap and Macro Textbooks

A standard objection to the money hypothesis is that nominal interest rates did (after a time) fall to their lower bound. The counterargument – which the textbook also suggests - is that, if the money supply had not contracted, long run neutrality would imply that eventually inflation would have to have been higher, and therefore real interest rates on average would be lower. So in one way the story about how higher inflation could avoid a slump is there.
What is missing is the link with inflation targeting. Because textbooks focus on the fiction of money supply targeting when giving their basic account of how monetary policy works, and then mention inflation targeting as a kind of add-on without relating it to the basic model, they fail to point out how a fixed inflation target cuts off this inflation expectations route to recovery. Quantitative Easing (QE) does not change this, because without higher inflation targets any increase in the money supply will not be allowed to be sustained enough to raise inflation. In this way inflation targeting institutionalises the failure of monetary policy that Friedman complained about in the 1930s. Where most of our textbooks fail is in making this clear.  
mainly macro
Simon Wren-Lewis | Professor of Economics, Oxford University

Would someone tell these folks that the "M" in MV=PT is M1 and not MB. Inflation targeting is not a transmission mechanism from MB to M1 to spending. To target something implies the ability to hit the target. The cb has not means to do this other than in targeting its desired interest rate through monetary policy. Moreover, no one actually believes that a cb will just sit by as inflation increases in spite of its having promised to do so in announcing an inflation target.


Ramanan said...

Looks like SW-L will remain confused all his life however hard he tries.

Dan Kervick said...

It's hopeless. These guys always seem to assume that as long as you label something a "target", the Fed can hit it.

The current generation of economists seem to have imbibed some fairy tale of Fed omnipotence in graduate school, and it is impossible to get them to believe that their mythical Olympian temple of money doesn't exist.

They don't understand how any of the actual machinery of central banking works and they are constantly flummoxed about why the Fed isn't building places of gold and restoring full employment.

The funniest thing is when they argue that because something happened, that's because the Fed wanted it to happen.

Honestly, they are almost like children where central banks are concerned.

Ignacio said...

Because they don't trust or believe in some sort of 'democracy' or 'government'; and because they have been educated in '(newtonian) physics envy'and must place their faith on central planning somewhere, legions of 'central bankism' zealots plague the academe (and practitioners too!) of economics.

You have to make real mind tricks to keep some sort of cohesive believe-system in the current chaos to keep market fundamentalism, corporate welfare and power and anti-government from falling apart and the deux-ex-machina of central banks and their omnipotent 'godly independent technocrats' managing the perfect newtonian machine of the economy is perfect for that.

Sad but true.

F. Beard said...

Moreover, no one actually believes that a cb will just sit by as inflation increases in spite of its having promised to do so in announcing an inflation target. Tom Hickey

But how can the cb stop inflation with interest rate hikes alone (unless they are exorbitant) since speculators profit from the spread between the rate they can borrow at and the rate prices are rising?

Will the US be finally forced to do the right thing and ban credit creation (at least temporarily) and bailout the entire population with new fiat?