In recent economic news, Minneapolis Fed President Narayana Kocherlakota changed his stance regarding our current extremely low interest rates .In his speech, Kocherlakota advocated keeping interest rates near zero until the unemployment rate drops below 5.5%, as long as inflation stays below 2.25%. This stance is a reversal from his previous stance that we would have to increase interest rates to raise borrowing costs and guard against high inflation (He is still clearly concerned about inflation, given his 2.25% stipulation).
The September 28th WSJ article by John Hilsenrath “Another Reason Kocherlakota Changed His Mind” talks about one of the inspirations behind his change of heart. MIT Professor Ivan Werning presented the idea that central banks should promise low interest rates during hard economic times, but that this policy would not necessarily lead to high inflation. As Werning says, “The whole point is to stimulate a consumption boom.”
Now, will it work? Some economists don’t care. Some, like Paul Krugman, believe that inflation will actually help recovery by encouraged spending. For Kocherlakota, however, keeping at least reasonably low levels of inflation is important. The low interest rates should encourage investment and hiring due to increased lending. Over time, this should reduce the unemployment rate, hopefully substantially. If this policy is also successful in encouraging consumption in a major way, overall economic recovery will be bolstered greatly.
Whether or not this can occur without inflation remains to be seen. “Easy money” policies are usually associated with relatively high inflation. Kocherlakota is hoping that this is not necessarily the case.
http://blogs.wsj.com/economics/2012/09/28/another-reason-kocherlakota-changed-his-mind/
6 Comments
What is the direction of causation here?
I won’t fill in the answers; you all should be able to do that.
There is no reason to think that several FOMC members won’t defect if inflation ticks up a notch or two. The “vow” to keep interest rates low could be a bluff to try to get markets to increase lending and to limit uncertainty. Inflation was 1.4% in July, 1.7% in August, and 2.0% in September. It will be interesting to see what the FOMC’s stance is if inflation continues to trend upward over the next few months.
In the macro literature, such promises suffer from “time inconsistency” — there’s no structure to push those making the promise to adhere to it, and incentives (if the economy recovers quickly) to renege.
In the Bloomberg article, Kocherlakota doesn’t seem to refer to any theory. He claims the shift is due to influences form other economists. And, “speaking to reporters after his speech, Kocherlakota said his view shifted in recent months partly because of a diminished inflation threat.”
Interesting to see when beliefs change to empirical experiences not only theory.
Yes, good to know that some people let facts get in the way. Kocherlakota was not extreme in his theory stance, he never denied that unemployment was illusory. For those macroeconomists who do deny “unemployment” it’s hard to think of any data that might get them to question their theoretical stance. They could probably even explain away deflation, if that arises.
Who are some of the prominent macroeconomists who deny unemployment? I am interested in how that can actually support such a claim.
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