Right after this I will post a long piece on monetary policy. Because I am still not well, I will take a brief break before starting to address yesterday’s comments. But I thought it might be helpful to clarify a few points that have been raised in several comments:
1. I am not an inflationist. If the Fed policy is 2% inflation, I favor they continue with business as usual, not adopt some sort of inflationary bailout of foolish debtors. If debts were made on expectations of 2% inflation, the Fed shouldn’t suddenly change its policy to 0% inflation. If they later decide a lower rate is better, don’t make the policy shift in the midst of the worst credit crisis in world history.
Actually I think their “dual mandate” means that they implicitly favor something closer to a 4.5% or 5.0% nominal GDP growth target. If so, they should continue on with that target, business as usual.
2. I am not much interested in the various sectors of the economy. I understand that the housing sector has declined sharply between mid-2006 and mid-2008, but except for a tiny drop in late 2007, real GDP rose continuously. Yes growth slowed in the first half of 2008, but I don’t know whether that was due to the real estate decline or the oil shock. So if commenters tell me that he “real problem” is housing, or banks, or some other sector, I will only believe you if you can show me that it would somehow prevent the Fed from boosting nominal GDP at 5% a year. That’s not to say that these things don’t matter, I can envision these sectoral shocks impacting productivity, and thus turning 5% nominal growth into a bit less real growth and a bit more inflation than we’d like, but there’s nothing we can do about that (from either monetary or demand-side fiscal policy.) And I think with 5% nominal growth we’d find that the “productivity shock” is much less than most people envision–partly because 5% nominal growth, even that sort of expected nominal growth, would immediately improve the banking system’s balance sheets.
3. I understand why people might find my causality thesis confusing. I claim tight money caused the late 2008 crisis, but my specifics seem to point to financial stress triggering an increase in money demand. There is precedence for this sort of “policy errors of omission” view of causality–Friedman and Schwartz used it for 1929-32 (although Krugman doesn’t buy it.) But I think it is especially appropriate for the modern Svenssonian view of monetary policy targeting the forecast, which the Fed seemed to be following in 1982-2007. (And Bernanke even hinted that they were following this approach.)
Acknowledgements
I’d like to thank Bill Woolsey for helping me out in the comments section. Bill and I both worked on unconventional monetary systems in the early 1990s, and he probably knows my thinking as well as anyone. He read this blog from the beginning. My colleague Aaron Jackson has also been very helpful. And while I am thanking people, I’d like to thank my wife and daughter for supporting me during the long and frustrating period when no one was paying any attention to my policy views (and when my Depression manuscript was rejected by CUP.) I’d also like to thank my sister Carol and colleague Swati Mukerjee for strongly encouraging me to go public with my policy views. (And my other colleagues.) And also my former student Tianning Yu, for suggesting that I start a blog to publicize my views.
