Scott Sumner Tries Not to Laugh at Those Silly Inflation Hawks
Scott writes:
Back in the Great Depression the inflation hawks said two things; monetary stimulus would do nothing (it was just pushing on a string) and it would do too much, producing hyperinflation. Keynes is now viewed as a genius, because he just made one of these two errors; assuming monetary stimulus would do nothing.
Then he goes on to show that we’ve learned nothing in 80 years; the opponents of more monetary stimulus are just as contradictory now, as they were back then.
I understand where Scott is coming from; if his worldview is right, then yeah, it obviously follows that the people opposing his solution are totally wrong. I even agree that the mainstream economists who oppose Scott, are just letting their common sense get in the way of their (crazy) models.
Yet even so, there’s nothing goofy about someone saying, “At best your policy proposal will do nothing, and at worst it will be awful.”
Suppose someone wants to throw knives at cancer patients. It is perfectly fine for me to say, “They will either miss their target, in which case they will have no effect, or they will hit the patient, in which case they will injure him further.” I don’t have to give some “zone” within which throwing a knife at the patient will be a good thing.
You think that’s too goofy, and you want an economic example? OK here’s one that maybe even Scott would agree with; I know plenty of other Chicago guys would. The government proposes to make every full-time employee get a free parking space, no farther than a 10 minute walk from his or her place of work. How do we analyze that?
(a) It is something that a particular employee would have gotten in his or her contract anyway, so it’s a superfluous regulation.
(b) It is not something that the employee would have gotten otherwise–the regulation is binding–and so the employee is made worse off. In particular, employees without cars in densely populated cities will be devastated by this idiotic regulation.
As the above two examples have illustrated, there’s nothing inherently nutty about saying a policy could be either impotent or disastrous, with no in-between. I realize Scott thinks this doesn’t apply to monetary “stimulus,” because modern recessions are the fault of insufficient inflation expectations. But, that’s sort of the very issue under dispute.
Love that analogy.
Major_Freedom,
You wrote:
“1. The steepest declines in US GDP ever took place post-1913.
2. Volatility has markedly increased post-1913.
3. The 19th century was characterized by two central bank experiments, both of which contained inflationary booms followed by deflationary busts, as well bank cartelizations with government privilege.”
This is fascinating stuff! Do you have any old blog comments that fully explain your thoughts on this? Ideally, would you like us to return to the gold standard, but in a better form? Or would you prefer a different kind of monetary system altogether?
“This is fascinating stuff!”
Well, OK. I myself think it’s old news.
“Do you have any old blog comments that fully explain your thoughts on this? I”
Murphy did a blog post on the “worst collapses” stuff back in May 2012:
https://mises.org/daily/6055/charting-fun-with-krugman
“Ideally, would you like us to return to the gold standard, but in a better form? Or would you prefer a different kind of monetary system altogether?”
Ideally, a free market in money *and* security/protection, so that the method of payment for such protection is negotiable.
That way, if group A wants to trade in paper notes issued by a monopoly, so be it, and if group B wants to trade in gold, so be it, and if group C wants to trade in digital currency, so be it.
This is possible,we just have to educate people in both economics and libertarian ethics. States are not laws of nature.
Major_Freedom,
Thanks!
Where can I read the best arguments for your monetary system?
Are there any major proponents of your ideal monetary / free banking system in the blogosphere?
If not, who out there advocates something close to it?
Major_Freedom,
Are you still sticking with this inflation prediction you made in February 2012?
http://www.themoneyillusion.com/?p=13330#comment-138989
“Once the money filters down into the consumer goods sector, which I am predicting is on its way and is going to be one of the largest, if not the largest, price inflations in the history of the US, Bernanke will then be compelled to slow/stop the printing presses.”
Not to put words in MF’s mouth, but the money is still being held in the Banks until they can recapitalize to the point that a stiff breeze wouldn’t bankrupt them.
“Are you still sticking with this inflation prediction you made in February 2012?”
If you mean this one:
“Once the money filters down into the consumer goods sector, which I am predicting is on its way and is going to be one of the largest, if not the largest, price inflations in the history of the US, Bernanke will then be compelled to slow/stop the printing presses. Once he does THAT, all the malinvestments that have not yet been liquidated from pre-2008, as well as all the new malinvestments that have been created since 2008, particularly in the asset/producer sector, is going to collapse and there will be yet another crash, deeper than even the 2008 crash..”
Then yes.
The following is in no way a retreat, because I stand by my prediction: but this statement is more of an analytical statement than an outright prediction, because there I wanted to make clear that the money the Fed has created since 2008, is in large part parked by the banks and paid interest by the Fed. So it might be the case that this “Once” doesn’t even transpire in my lifetime.
In other words, the “prediction” would be “falsfied” if these reserves do not end up in general circulation. So the question is if and when they do. I don’t know when it will happen, but I suspect it will, and will gladly admit to being wrong if it doesn’t happen.
I agree with your reasoning and I think that in my opinion the reserves will escape and (price) inflation will happen. There’s still a measurement problem in that not all prices everywhere will inflate equally, it depends on where those reserves bleed into the general circulation.
Doesn’t this just open up the old Schrodinger’s Cat problem though? Suppose I claim to be a millionaire because I have one million dollars locked in a steel box deep underground at a geo-cache known only to me. So when people ask to see the million dollars I won’t allow it, and when people ask how I came to be a millionaire I won’t tell them. When people ask what I’m going to spend it on I tell them I don’t intend to spend it.
Am I a millionaire at all?
Hey wait! Quantum mechanics can apply to the macro world.
“Where can I read the best arguments for your monetary system?”
Anarcho-capitalist literature.
The monetary system would be “run” the same way as every other commodity production: Private property rights at the individual level.
>Are there any major proponents of your ideal monetary / free banking system in the blogosphere?
Yes.
on volatility post 1913;
http://www.youtube.com/watch?v=yLynuQebyUM
Dr. Murphy,
You wrote:
“As the above two examples have illustrated, there’s nothing inherently nutty about saying a policy could be either impotent or disastrous, with no in-between. I realize Scott thinks this doesn’t apply to monetary “stimulus,” because modern recessions are the fault of insufficient inflation expectations. But, that’s sort of the very issue under dispute.”
Is that really the issue that’s under dispute? I don’t think either you or Major_Freedom dispute the fact that easier money would have made this recession much much much much less severe than it has been.
Pretty sure I don’t need to deny that printing up pieces of paper and paying all unemployed people to waste capital, can increase the statistic of what you call “employment”, for me to reject your proposed inflation solution on other, more serious grounds.
TravisV, at best Austrians agree with Scott, in the same way that we agree, “Physical pain in our modern world is caused by failure to continue taking heroin.”
Dr. Murphy,
The heroin metaphor is pretty ridiculous. Consider South Korea. They’ve had plenty of moderate inflation since 1950. Are they messed up on heroin as a result? Not even close. South Korea is vastly more prosperous and has a vastly higher standard of living than they had in 1950. Give me a break.
Yes, there are drugs less bad than heroin, if that’s your point.
Major_Freedom,
How in the world do you know that South Korea would be enjoying some kind of awesome utopia if only they would have reined in the money supply?
Answer: you don’t.
How do you know that South Korea wouldn’t have a higher living standard today (you don’t need an awesome Utopia…) if they had done no or less monetary inflation since 1950?
Answer: you don’t.
As an addition. Maybe a FED official (Richard Fisher from Dallas FED) has more credibility to you. He sounds a bit like Bob here:
“we cannot live in fear that gee whiz the market is going to be unhappy that we are not giving them more monetary cocaine,”
http://www.moneynews.com/FinanceNews/federal-reserve-richard-fisher-bond-buying-rally/2013/06/05/id/508102?s=al&promo_code=13B96-1
Richard Fisher is openly ignorant of economics, which is why he talks in terms of sailing analogies all the time. He has close to negative credibility with me.
“Richard Fisher is openly ignorant of economics, ”
But I thought the guys running the thing were competent and wise economics experts! If they are ignorant, openly or not, then why should we let them be in charge of manipulations. End the Fed – it clearly is run by incompetent morons anyway!
“How in the world do you know that South Korea would be enjoying some kind of awesome utopia if only they would have reined in the money supply?”
Same reason I know unhampered economic calculation leads to more sustainable capital formation and higher standards of living.
“Answer: you don’t.”
So was that a real question, or not?
By the way, how do you guys know that tighter money wouldn’t result in bigger government / more bailouts, etc? Do you really think the electorate would be willing to put up with years and years of mass unemployment without electing some kind of big-government strongman?
Nobody denies this kind of dynamics that are inherent in democracies.
What is being argued is that less monetary stimulus in the past would have led to better healthier economies with less bubbles and sounder fundamentals, and hence less (severe) recessions and less pressure to increase government in the first place.
And that monetary managing leads and even mainly leads to bubbles is told us by non-other than Krugman himself:
“After all, the Fed’s ability to manage the economy mainly comes from its ability to create booms and busts in the housing market.”
I guess he said mainly because the FED can cause booms and busts in other markets (like the stock market or bond market) as well.
“By the way, how do you guys know that tighter money wouldn’t result in bigger government / more bailouts, etc?”
How can you know that looser money wouldn’t?
“Do you really think the electorate would be willing to put up with years and years of mass unemployment without electing some kind of big-government strongman?”
Do you really think that continuing the same inflationism that make things worse, that only increasingly sized deflations can cure, is better?
You’re like a heroin addict afraid of what might happen to his body if he stops now instead of later on after more years of using.
My understanding (based on careful reading of leaflets distributed around train stations) is that going cold turkey after heroin can never kill you (but feels decidedly uncomfortable). On the other hand, going cold turkey after alcohol can indeed be lethal (presuming you are addicted).
What I’m getting at here is that a cold turkey solution often isn’t the best idea, but increasing the dosage is never a good idea.
“I’d Push the Button” – Leonard E. Read
http://www.fee.org/files/docLib/2005_05.pdf
People would die and the button pusher would be responsible. Yes, I do understand that from a certain perspective the dead person would be personally responsible for their lack of foresight, but once they are safely dead, any claim can be made.
A collapsing civilization does a lot of collateral damage… sometimes you might just be in the wrong place at the wrong time.
Don’t you dare say, “greater good” or anything remotely similar. We already know where that one goes.
Ebeling: For 70 years the government has asserted it’s right and duty to plan the retirement of the American people through a compulsory pension system perversely called Social Security. Now finally they game is up with not enough people in the working-age population to subsidize all the retirees who have been promised a certain level of income in their latter years. However, rather than admit it’s all been a fraud and simply end this forced intergenerational redistribution of wealth, even the pro-market advocates propose various tweakings of the system: raise the retirement age, lower the promised benefits, and allow Americans to “invest” a portion of their plundered money into government-approved mutual-fund accounts.
Look, I get where the guy is coming from. In Australia we have just had a government (a Fabian socialist government) increase the plunder from 9% of your income to 12% but people are standing around sucking it up. Sure, the socialists that did this will get shown the door (with generous pensions) but the new guys aren’t about to rock the boat.
Only when a lot of people clearly see the problem, can there be an answer to the problem. Clobbering them won’t help that, they have to get the time to think about it and understand why central planning doesn’t work.
TravisV,
South Korea has never had a recession because they have always managed inflation expectations (unlike the fed here in the US)??
South Korea has never had a recession? Really? I didn’t know that but if so, that only supports my argument.
omg… Of course there were recessions in South Korea…
TravisV,
What??
Look, Murphy’s point was that Austrians think more easier money during a recession is bad because it will further distort capital allocation, which is the Austrian story for why recessions happen.
Hence, the heroin analogy – more heroin will make an addict feel better if he is crashing, but will only make the pain later when he does have to crash worse.
But, you think because SK has had moderate inflation and prosperity for the last 50+ years that this is silly.
You said nothing about what SK has actually done during recessions – or if it has not had any because its easy money policies- or whether it was able to prevent them or mitigate them with easy money. Just stating that SK has moderate inflation over decades and prosperity doesn’t say anything about what policies work either to prevent recessions or mitigate them.
Do Bob Murphy, Major_Freedom, etc. genuinely believe that tight money would result in less business cycle volatility? Really? There was plenty of business cycle volatility even before the creation of the Fed.
TravisV,
I guess Rothbard didn’t know there were business cycles before the fed either when he wrote the Panic of 1819.
What argument irrelevant to the subject at hand will you bring up now TravisV?
1. The steepest declines in US GDP ever took place post-1913.
2. Volatility has markedly increased post-1913.
3. The 19th century was characterized by two central bank experiments, both of which contained inflationary booms followed by deflationary busts, as well bank cartelizations with government privilege.
“2. Volatility has markedly increased post-1913.”
According to what studies? And “volatility ” by what measures?
“And “volatility ” by what measures?”
Name one.
Volatility in real GDP per capita, annualized, for example, markedly increased.
The more I think about it, I think the Austrians largely agree with market monetarists about the way the world works, etc. It’s just that the Austrians have a vision of Utopia that’s much more important to them than making actual real world progress.
Major_Freedom wrote an excellent old comment below illustrating the real difference between the two approaches. Note: the difference has nothing to do with disagreement about empirical facts:
http://www.themoneyillusion.com/?p=15602#comment-173676
“Sure, I have always said that NGDP targeting is superior to consumer price level targeting. But I also think productivity norm is superior to NGDP targeting, and I also think a free market in money production is superior to the productivity norm.
I vehemently reject the illusion that we have to choose between NGDP targeting and dual mandate. If I said killing 1 million innocent people is superior to killing 100 million innocent people, then it would be absurd to support killing 1 million people on the silly foundation that “we have to choose between these two, so choose.”
I think anyone who did support it would only be doing so to manifest a desire to harm people. The fake “If it’s not 1 million, it will be 100 million” is a cop out.
Life is not tough. Like is wonderful. Ideas can change. Knowledge can spread. We are not doomed to NGDP or dual mandate.
I refuse to capitulate, Morgan. If enough people thought like me, NGDP targeting would be an impossibility and the optimal that you say is not possible, will become possible.
If we lived in a concentration camp, and everyone capitulated, then who will abolish the concentration camps? The guards? No, the prisoners are the only hope. But they can’t abolish it if they are being educated by people who apologize for the guards.
Being a true intellectual is not like a 9-5 job where you punch in and punch out and secure your income in the warm bosom of taxpayer financing. Those are court intellectuals. Technocrats. Bureaucrats. Political strategists. Opportunists. True intellectuals are radicals, bordering on insanity in the eyes of others, at the fringe.
When you look back on history, and you think of influential intellectuals, do you think of back office econometricians who collect economic data for the statesmen’s pleasure? Or do you think of those who were so crazy in the eyes of others that the rabble jailed them and killed them (Socrates)?”
The only way that you can be serious about “progress”, is if you held that NGDP targeting is but a stage in a larger, grandeur movement towards the superior monetary order.
But I see no market monetarist who is preaching about pragmatism and progress, to be advocating for NGDP targeting on anything but final, once and for all grounds.
So what happens if NGDP targeting is adopted worldwide? Will the spirit of progress remain, thus leading you to be what I am now, an opponent of NGDP targeting, or will you cease seeking progress, and sit back and pretend that NGDP targeting (or some other “income” target) is the best there is?
It’s easy to appear as pragmatic and prudent when what you want is so very close to the status quo. It’s easy to dismiss the more future oriented thinkers as dogmatic extremists. But we’re just wanting to skip unneeded, and destructive “stages”.
I reject the notion that progress can only occur with baby steps. History has shown that radical changes are possible.
I know I use the slavery analogy a lot, but it’s so useful: I’d rather risk starvation and disease facing the world directly after trying to free myself from slavery, then settling on an additional hour of break per day from the master in the name of baby step progress, and hope that the next generation of slaves get 2 hours and then 3 hours, and then 24 hours per day.
See, I hope you understand that I am not calling for an abolition of the Fed for you or anyone else who wants to keep the Fed. Just for those who want out of the dollar system. Allow competing monies without legal tender, regulation, or taxation. Bitcoins, e.g.
It would be easy to legalize true monetary competition. It would take a few weeks to draft the bill, a single afternoon of Congressional debate and discussion, and a few moments of signatures.
If this is too “radical” for you, then fine, use us as guideposts to direct your own supposedly superior piecemeal ideology. But don’t expect us to feel guilty about going where you are too afraid to tread.
There’s nothing inherently nutty about saying a policy is simultaneously impotent AND disastrous.
If you are driving towards a cliff, it might cross your mind to fire to the car. However, this would be impotent (because you are still hurtling towards the cliff) and also disastrous (because now even if some miracle does save you from the cliff, you will be burning to death).
err … to set fire to the car …
I blame autocorrect.
there’s nothing inherently nutty about saying a policy could be either impotent or disastrous, with no in-between.
Not inherently, but with respect to inflation? Did someone prove that the numbers 2 through 5 don’t just exist and I missed it?
It’s not that inflation between 2 and 5% per annum doesn’t exist or can’t happen under “market monetarist” policies; it’s that the higher inflation would be achieved in exchange for no net economic benefit. It would just shift around resources.
Remember, you can always goose whatever econometric you want; it’s no so easy to goose the “genuine economic goodness” that these are supposed to approximate.
We could make NGDP whatever we wanted it to be by printing $X dollars and using it to buy the “services” of random people. Doesn’t mean RGDP has improved, or that the economy is more productive, or that it’s organized on a more sustainable basis that identifies stable comparative advantages, etc etc etc.
“Market monetarism” sounds like a health food meth head. Or Keynesian-lite for business major frat boys.
What is the mechanism supposed to be for squirting the new funny money into society? New loans during the crash? Do you guess at how much CPI inflation you want to target and squirt in a bunch of funny money and then wait to see if you hit the target? If you miss, do you then increase the amount of the squirts? Or do you always squirt the same amount and live with it? Sumner is a central bank guy, right? He’s not talking about Congress spending new funny money into existence, right?
If banks won’t lend, do you jail the bankers?
I’m thinking the idea is that central banks are omnipotent.
They can bring about any inflation target they want, “through buying the world is need be” (Sumner’s words paraphrased)
Well, maybe they could buy all of our underwater houses for 2x accessed value.
So, it’s like MMT for rich people? Instead of the MMT free lunch of Congress squirting new net financial assets at the poor out of thin air, the central bank buys the assets of rich people with new funny money at inflated prices so they can maintain their lifestyles?
Does this “inflation expectations” thing view the populace as truly understanding the system or more like greyhounds chasing the mechanical rabbit?
I think you’re way too forgiving in his critique.
He’s just conflating the discussion of the scale of the stimulus by painting broad strokes.
Small monetary stimulus will be bad but negligible.
Medium amounts of monetary stimulus will be worse.
Large amounts of monetary stimulus will be disastrous.
I don’t see any contradiction in language other than the straw man he created.
Scott Sumner would have done better to remain silent here. He argues that monetary stimulus can mechanically boost nominal GDP, yet despite QE, “V” (velocity of money) collapsed and nominal GDP grew slightly. The Keynesians and monetarists can only be disillusioned. This proves that the outcome of monetary policy on the economy is very uncertain, at least in the short term. As Samuelson said, with which I agree for once:
“In terms of the quantity theory of money, we may say that the velocity of circulation of money does not remain constant. “You can lead a horse to water, but you can’t make him drink.” You can force money on the system in exchange for government bonds, its close money substitute; but you can’t make the money circulate against new goods and new jobs.”
The demand for money is neither stable nor controllable. However, when the economy recovers, V could go back (with confidence), and bank excess reserves spread in the economy which could lead to a high inflation rate. The quantity theory is not for me discredited. There is a causal link between money supply and nominal output (PQ) but not as large or as consistently, at least not always.
The people rambling on about Velocity and Nominal GDP need to understand two things.
1.) Velocity of money is pretty much garbage. This concept was invented in order to add more sophistication to economic models, but in reality it’s done nothing more than make our analysis far more complicated than it needs to be.
2. GDP (especially Nominal GDP) is a terrible measuring tool to gauge the economy on. Aside from being incredibly misleading (since the value of GDP can be manipulated through inflation and other types of government/private shenanigans), GDP itself is a silly concept. The assumption that all a given economy produces can be calculated to one given (even if you said that this amount is an approximate or an average) is incredibly pretentious.
Oh, by the way Bob, if you’re interested in books on economics, I’ve written my own book called “The Little Book of Economic Myths and Fallacies.” Walter Block has already read it and loved it. If you’re interested, I can have a copy shipped to you. Here is the link if you want to check it out.
http://www.lulu.com/shop/ken-pruitt/the-little-book-of-economic-myths-and-fallacies/paperback/product-20949572.html
It’s worth noting that all economic aggregates are broken, including GDP.
However, it isn’t completely useless because if you line up all the nations in terms of GDP per capita (and put that into a common currency) you can see that high GDP per capita nations are recognizably preferable in terms of where you would want to live, and generally how those people live.
People get carried away with these “rough guide” macro figures, and they read a lot more into it. I agree these figures can be manipulated… breaking enough windows makes GDP go up. We have a problem also isolating voluntary economic activity (where both sides benefit) from compulsory economic activity (stuff is just done to fulfil regulations, but no one would have done it otherwise). You might have a brilliant tax accountant who is very good at optimizing for minimum tax, and even people might voluntarily go to the guy, but all that work is just a compensation for an overly complex tax system in the first place. It isn’t productive.
As for the “velocity of money” in principle money serves the purpose of facilitating transactions, so more velocity means the money is correctly doing the job it was designed for. That seems like a good thing to me.
There’s a problem in practice that we have various different things that quality as “money” so if you were going to do the measurement properly you would not boil it down to a single number. You would need many numbers: a velocity of cash, a velocity of mortgage debt, a velocity of bank reserves, a velocity of checking accounts, etc. It should be obvious that cash changes hands a lot faster than mortgage debt or bank reserves, so trying to combine those into an overall figure just hides the reality. Measuring exactly which transactions are conducted in cash is not something we normally do, so people feel that stuff that doesn’t get measured isn’t worth studying.
“As for the “velocity of money” in principle money serves the purpose of facilitating transactions, so more velocity means the money is correctly doing the job it was designed for. That seems like a good thing to me.”
Most new innovations to economic modeling sound good at first. But to your comment, money by definition is going to correctly do the job that it was “designed” to do. If it ceases to do so, then the prevailing money ceases to be money and a new commodity will take its place. To try and calculate velocity of money is a pretty moot task in and of itself; not only do you (in reality) learn nothing from it, the data that you get from it is useless since it is out of date as soon as you get it (as is the case with most, not all, economic statistics of this nature).
“However, it isn’t completely useless because if you line up all the nations in terms of GDP per capita (and put that into a common currency) you can see that high GDP per capita nations are recognizably preferable in terms of where you would want to live, and generally how those people live.”
We can use our eyes and ears without formal data collection for that. We don’t need GDP stats.
If for whatever reason GDP statistics in 1985 showed that the USSR was wealthier than the US, I would still go by my eyes and ears and hold the US to still be wealthier.
What you’re saying with GDP is sort of like saying “Palm reading is not *completely* useless, because it just so happens that those whose palms read wealth and prosperity last night, actually corresponds more or less to real world wealth differences.”
I actually trust your “recognizably preferably” judgment more so than GDP per capita stats.
There’s a host of happiness indices, the Heritage Freedom Index, economic development indicators, the pretentiously named “Genuine Progress Indicator”… whatever you like. How repeatable they are is a bit questionable. I would guess if you sent 10 different teams out to research these things and maintained strict isolation between the teams so they could not communicate in any way, you would get 10 different measurements of the same thing.
Every other week a macro economist comes up with a new index of something or other. Yeah, admittedly a bit like palm reading, not entirely useless.
If the macro economists aren’t out there taking measurements and trying to optimize something, then what do they do then?
Just came across this recently as an example…
http://jonova.s3.amazonaws.com/graphs/co2/co2-emissions-gdp.png
So when you look at that graph you can see a very strong correlation between the two variables. It’s so hard to believe that sort of stuff happens by complete accident.
I’m aware that correlation can mean various things, it’s nothing more than a window to peek through, not the whole story by any means. That said, it does suggest that GDP can be a useful guide at times.
http://www.cato.org/publications/commentary/wheres-inflation-coming-neighborhood
I still can not get past the individual being robbed to pay for the bad decisions of banks. The whole thing is one giant counterfeiting mechanism that transfers wealth in terms of purchasing power from the poor saps of the world to banking institutions. This is the case regardless some calculation of inflation.
The other part of the arguments for money creation does not stand up to accounting. That is that when the money is digitally created in the balance of bank the accounting is finished. The new money exists as an asset for one party to do with as they wish and is taken away from the losing party. The only part left is for the prices to rise accordingly. And they will eventually do so. I assume that the central banks withdraw this money from the system but it is mechanically harder to do so as the central bank must injure those very parties it helped in the first place.
ZLB says fiscal policy won’t crowd out private investment. Do fiscal policy. You need to read “only game in town” in the context of everything else Krugman was saying 2008, which was that we needed monetary stimulus but that we had real trouble with an expectations trap.
This is a hard concept to explain, so let me use the analogy of Lucas’s critique of discretionary monetary stimulus. Lucas argued that discretionary monetary policy was undesirable. He argued that monetary stimulus was ineffective if anticipated, as it would already be factored into wages and prices. Then people would ask Lucas why unanticipated stimulus would not work. He replied that one had to think in terms of systematic policy rules that one could write down on a piece of paper, otherwise there was little hope of producing a welfare-enhancing monetary regime. Suppose you wrote down “Every time unemployment rises above 7% we’ll do an unexpected monetary stimulus.” Then it would no longer be unexpected! In other words, the monetary authority could only surprise the public by doing “wild and crazy” things which people had no reason to expect. How likely is that to work?