Bernanke gives his (and the Fed chairman’s) first regular press conference today, part of the Feds good will campaign to answer the mistaken criticism of the Fed’s ”easy” policy stance. Watch any American financial show (Yahoo Finances tech ticker, Kudlow ect) and you will hear pundits talk about how the Feds zero interest rate policy is artificial or a drug. It is important that Bernanke get out ahead of this.
It seems to me that as money is a human invention, any monetary system or policy stance is necessarily artificial. Any critique of current policy drawing upon the ”artificial stimulus” arguments is thus-for my part-missing the point. What matters to me is the behavior of the economic figures which monetary policy directly sets: principally nominal GDP, wage indices, the CPI, and financial markets. With this in mind I’ll address a more worthy criticism. I keep reading about how ”inflation is rising”, especially in U.S. media. This is true in a literal sense, but not especially useful. Consider the plot below:
U.S. consumer prices are still well below the path implied by the Feds pre crisis ”inflation target” which is clearly very stable and predictable. We can have months and months of 3% (yearly rate) CPI inflation before we return to the old trend. It is just as-if not more-important that the Fed avoid undershooting as it avoid overshooting. An inflation target is a two way street. For the target to be credible, episodes of below target inflation should be offset by higher infaltion. This anchors longterm inflation expectations which are what sets medium run inflation.
Übereconomist Tyler Cowen mulls the future of the Euro. It is reassuring to see that a thinker as measured and dispassionate as Cowen agreeing with my view, if for different reasons.
My view is that Ireland,Greece, Portugal and perhaps Spain are likely to leave the Euro within three years because current ECB policy (set to keep German CPI inflation under 2%) is inadequate to maintain stable NGDP growth in these massively indebted countries. The ECB is in a real bind. NGDP is growing appropriately in Germany, but is kinda to very weak in other EMU states. If they substantially ease policy they risk having (heaven forbid!) 3-4% headline inflation in Germany. This would cause the middle tier Eurozone countries (Finland, Benelux, France, Denmark*,Italy) to join the economic recovery in earnest, and might be enough to help at least Spain muddle through. But again, that would require that German elites tolerate higher inflation.
Either way though, Ireland, Portugal and Greece are in a bad spot. But lets just consider Ireland here, because if we average the latent indices of economic trouble and sympatheticness they come out on top. The Irish owe a truly heroic amount of money relative to the size of their economy. Leaving the Euro is problematic, but it is ultimately the only way to get nominal spending back on track, which is the only way for previously taken debt to be serviced and for the economy to recover. I am assuming here of course that the new Irish pound would eventually stabilize and allow nominal spending in Euro terms to grow.
The only alternatives I see is default or targeted QE (say print a bunch of money and give it to the Irish state). These are unfair to other EMU members, but you know what? It is too late to go back and do the EMU dance right. The Euro was a risky political project with too much haste. It was never clear that the disparate economies of Europe would always need similar monetary policy (the case within all other big currency areas-see California v Texas) but now that bind is imposed and we need to make the best of a bad situation. Facilitate the exit of the PIIGS or print them enough money to pay their debts.
To make the point that Ireland is suffering from a profound shortage of nominal spending (a deflationary depression) and that the macroeconomic response to monetary policy has diverged between Ireland and the dominant EMU member Germany, Consider these plots:
Certainly looks to me like Ireland could use more demand, at that Germany is just fine. To say that Ireland will stay on the Euro requires one to believe: [A] The Irish AS curve will quickly and significantly shift rightward and/or that the ECB will massively devalue the Euro and cause an inflation in Germany. [B] That Irish politicians will tolerate a decade long depression.
P.S. could there be some way of decreasing velocity in Germany and thus allowing greater monetary stimulus for the other members? Could the German federal government raise the VAT or somehow subsidize savings…? Would this be preferable to simply formally assuming a big fraction of PIIGS debt?
I was in Amsterdam this week doing my best to help Team Uppsala win the 2011 Econometric Game. Rumor is that we came in an unofficial 4th, but I digress. This year’s case was to use genetic markers as instrumental variables. The idea being that genes give exogenous variation in certain behaviors.
The two cases we dealt with were a gene which inhibits alcohol metabolism which we used to instrument maternal alcohol consumption, and a gene which increases the probability of being fat which we used in the first stage of an IV model explaining socialization problems in kids. I had never heard of using genes as instruments but upon consideration, it seems like a potentially fantastic idea. Almost makes me want to be a micro econometrician, well not really but it is interesting.
I was rather far from my macroeconomic element but the competition was a lot of fun, especially meeting so many smart budding econometricians. I advise any PhD or Masters students out there to have your department apply for the games next year.