These days there seem to be two types of thinkers in the world of central banking. On one side there are serious people – people who believe that we should raise interest rates in the face of high unemployment and falling inflation, because, well, that’s what serious people do. On the other side there are unserious people, who believe that central banks should fight deflation as well as inflation, and try to prevent the current slump from turning into a quasi-permanent state of depression. How ridiculous can you get?
In Sweden, my former colleague Lars Svensson, now at the Riksbank, is concerned about the desire of his colleagues to raise interest rates in the face of inflation far below target and an economy that is a long way from having fully recovered. But what does he know? He’s just one of the world’s leading monetary economists, having spent a great deal of time studying problems of monetary policy at the zero lower bound.
In Britain, Adam Posen, on the Monetary Policy Committee, urges more action:
We will only know we will have done enough with QE [quantitative easing] or other monetary stimulus when we have clear indications that our policies are moving the desired variables — market interest rates, wages, output, employment, and inflation expectations — sufficiently and in the right directions on a sustained basis. I do not think that is not enough for a central bank to say, ‘Look, we expanded our balance sheet more than any time in history,’ or ‘we did things we never did before,’ and argue that therefore we must have done a lot, if not too much (not that the Bank of England has done so). In my opinion, that is backwards logic. It would be like saying ‘that fire must be out, because we’ve already pumped more water than for any previous fire we’ve fought,’ or ‘we must have gotten to our destination, because I’ve been driving for hours and we’ve already used a full tank of gas.
But what does he know? He’s just the leading English-speaking expert on Japan’s lost decade.
Snark aside, the rise of the pain caucus is truly amazing – I’m a hardened cynic, yet even I didn’t see that one coming. As Posen points out, mainstream macroeconomics – which suggests that we need a lot more stimulus, monetary and fiscal – has actually held up very well in this crisis; it has, above all, made the right predictions about inflation and interest rates, while the doctrines underlying the pain caucus have gotten it all wrong. Yet “serious” policy makers are rejecting the theory that works in favor of theories that don’t.