Monday, July 19, 2010

Economists Blogging about the Fed

Econobrowser has a nice post in which he invites three young leading macro-economists to post on the topic of whether the Fed's inflation target is too high or not.

Predictably, however, the post was a total disappointment. According to the authors calculations, "The optimal inflation rate implied by the model is 1.2% per year."

Wow. That's pretty low, isn't it? The authors, predictably, do not grasp that if the Fed predicts 1% inflation and does nothing to get us to the "target" of 2%, then for all intents-and-purposes, we've got a 1% inflation rate. There is also no discussion about what I believe -- that the lower bound only matters because Ben Bernanke has a personal distaste for QE. They also write that if the Fed set an inflation target of 0%, then the zero lower bound would bind 15% of the time. This sounds highly suspicious. With a 3.5% target, we'd be in liquidity trap territory 4% of the time. (Is liquidity trap prevalence really so insensitive to the target??? That sounds pretty incredibly to me...) The authors also write that "raising the target rate from 1.2% to 4% per year is equivalent to permanently reducing consumption by nearly 2%." Again, color me suspicious that inflation is that costly given that w/ a 4% inflation target, we would not now be stuck in a deep recession... This implies shoe-leather costs of inflation are on the order of 3-4%. In any case, I think a 4% target is much too high. If I were Chairman Bernanke, I might raise the target to 2.5%.

I have a strong suspicion that this "economic research" is driven by priors and numbers which have largely been made up.

7 comments:

  1. Wouldn't 5% inflation for about 10 years go a long way towards solving the mortgage problem? I, for one, would no longer be upside down on my mortgage, and would be paying it off in cheaper dollars.

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  2. What is your feeling on an NGDP target of the type that McCallum and Sumner have argued for?

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  3. I support the NGDP target or something like it... 5% NGDP growth would certainly go a long way toward solving the mortgage problem!

    The key problem is that the Fed is unwilling to do anything to hit its own inflation target though, so even if it had an NGDP target, one wonders what would be different...

    -TV

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  4. The problem is that ZIRP and QE create asset bubbles, not wage inflation. Good luck getting wages to keep up with the cost of food and gas with 20% underemployment and businesses responding to incremental demand with offshoring and automation rather than hiring.

    http://www.wcvarones.com/2010/07/devaluation-is-only-way-out.html

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  5. More QE would also weaken the dollar. This would be inflationary in two ways, first by making the price of oil and other imports higher, and secondly, by stimulating domestic industries which export or compete with imports. Asset bubbles would be a third avenue, but if the Fed uses QE to buy 30-year Treasuries, color me suspicious that this would lead to a problematic asset bubble...

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  6. Higher oil prices will show up in the CPI, but that's not the kind of inflation you want - when OPEC raises oil prices, that doesn't lead to lower unemployment. What people have in mind is the wage-price spiral and how to restart it, but the exact mechanism by which that happens has been left unsaid. We haven't actually seen that kind of inflation for 25 years, my belief is that the "pricing power" of workers and firms has gone down due to technology and globalization.

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  7. Maybe rigorous enforcement of the prohibition of employing people who can't lawfully work in the US, and who are exploited with low wages, along with an increase in the minimum wage would give the old wage-price spiral a kick start?

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