Bill Mitchell on the Great Moderation

      In my last post we contrasted the Great Moderation in the memory of two notable macroeconoimsts-Scott Sumner and Bill Mitchell.

      It's certainly fascinating to behold the glowing terms in which Scott Sumner remembers it:

      "For the purpose of analyzing economic policy, a student would be better equipped with the quantity theory of money (together with the expectations-augmented Phillips curve) than the Keynesian Cross. In the United States today fiscal policymakers have completely abdicated responsibility for economic stabilization. Their inability to cope with persistently large government deficits has left them unable to even imagine trying to reach consensus on countercyclical fiscal policy in a timely fashion. All attempts at stabilization are left to monetary policy. When a recession ensues, as it did recently in the United States, fiscal policymakers merely begin discussions of what the Federal Reserve did wrong."
  
        "Reading this brought tears to my eyes. A mere 20 years ago we were in a golden age of macroeconomics. Now a new dark age has set in, as the forces of old Keynesianism have made Mankiw’s vision seem like a distant dream."

          http://diaryofarepublicanhater.blogspot.com/2012/07/great-moderation-it-was-best-of-times.html

        Mitchell remembers it in-less glowing terms. Which is a good thing, I've long felt that while, yes, this crisis has been awful, there's way too much revisionist history, much of which Sumner himself is driving. The Great Moderation was never so great.

        Indeed, what's particularly disquieting is the way that mainstream Macro guys in celebrating the "price stability" of the Great Moderation totally gloss over the significant costs of deliberate disinflation-the macro and social costs are considerable and not even referred to for the most part. You'll certainly never get Sumner to acknowledge it-Krugam on the other hand I think would though he's an outlier in this regard which is why he's hated by large parts of the Macro establishment-just check any number of dozen missives Stephen Williamson has fired at him.

        There is nothing the establishment hates more than for you to call into question what Williamson calls "Modern Macro"-what MM amounts to for him is Post-Lucas Macro. Indeed, even in SW's dispute with Sumner-and it should be clear I'm far from wholly on Sumner's side-SW kind of showed his hand by admitting that a big objection he had to NGDP is that it might make past Fed actions look stupid-as he says 'you've got to protect your buddies.'

       "The variability of NGDP about trend has been substantial in the post-1947 period - basically on the order of variability about trend in real GDP. You'll note that the two HP-filtered time series in the chart follow each other closely. If we were to judge past monetary policy performance by variability in NGDP, that performance would appear to be poor. What's that tell you? It will be a cold day in hell when the Fed adopts NGDP targeting. Just as the Fed likes the Taylor rule, as it confirms the Fed's belief in the wisdom of its own actions, the Fed will not buy into a policy rule that makes its previous actions look stupid."

         http://newmonetarism.blogspot.com/2012/07/some-doubts-about-ngdp-targeting.html

         "The Fed is you and your buddies. Every institution does this. There's an implicit agreement that you always defend the institution. The institution does not like people who don't do that."
  
        This is the classic insularity of powerful institutions and why they resist change-again, this is apart from the question of whether Sumner's change is the kind we need. Indeed, on a deeper level, Sumner is trying to protect the status quo as the quote above makes clear.

         Mitchell speaks of something you'll never hear Sumner or SW ever breath-the very real negative macro and social effects of the deliberate disinflation the Fed and other central banks around the world have augured around the world. Note, this is the policy of the Fed that SW is protecting-he doesn't like NGDP even as it implicitly questions the price stability first policy of CBs since Volcker:

         "The “Great Moderation” reduced variability but also reduced overall growth rates. Further it is clear that the high real GDP growth rates of the 1960s were associated with generally low inflation rates."

         "Clearly, the subdued growth that occurred in the “Great Moderation” was also associated with persistently high unemployment rates in all nations. The welfare losses involved were enormous. All sorts of excuses were given for this rise in the unemployment rate but it is obvious that it was because policy makers prevented real GDP growth rates from reaching potential."

          http://bilbo.economicoutlook.net/blog/?p=7554

         "They started to use unemployment as a policy tool in their misguided fight against inflation and then tried to doctor the facts with new theories like the natural rate of unemployment. Please read my blog – The dreaded NAIRU is still about! – for more discussion on this point."

         And this is what you certainly won't ever hear Williamson admit nor will Sumner admit it-though his NGDP targeting agenda is implicitly critical of price stability at all costs which is why people more directly in the establishment like Williamson find it unseemly-you have to visualize this as almost literally having bad manners from the standpoint of the establishment. To go off and say all these wrong things like Krugman when he criticized "Modern Macro" back in 2009 is like someone who comes into mixed company and passes gas. or is dressed in crummy clothes-it's a sign of almost literally social cluelessness.

tradeoff:

         "The real question then is how large are the output losses following discretionary disinflation? The magnitude of the real losses is considered to depend on the degree of inflation persistence. The increased use of inflation targeting has been associated with persistently high (though declining) unemployment in most OECD economies. Some economists argue that inflation-first monetary policy (of which inflation targeting is an evolved form) has caused the lack of jobs, especially in European economies, over the 1990s."

         "While some extreme elements of the profession, who still consider rational expectations to be a reasonable assumption, will deny any real output effects, most economists acknowledge that any disinflation engendered by this approach will be accompanied by a period of reduced output and increased unemployment (and related social costs) because a period of (temporary) slack is required to break inflationary expectations."

           "To measure the real losses economists have used the concept of a sacrifice ratio which is the accumulated loss of output during a disinflation episode as a percentage of initial output expressed as ratio of the accumulated reduction in the inflation rate. So if the sacrifice ratio was two it would mean that a one-point reduction in the trend inflation rate is associated with a GDP loss equivalent to 2 per cent of initial output."

           The sacrifice ratio-I'll give you $100 if you can get Sumner to admit this exists. I'm not too worried. The severe costs of CB disinflation is what Steve Waldman no doubt had in his recent post "Stabilizing Prices is Immoral"

           http://www.interfluidity.com/v2/3359.html

          Although I understand what he meant-that it is objectionable the way disinflation is celebrated without even acknowledging the high costs much less asking if they are worth it, he probably phrased this a little awkwardly. It makes him easy for smug establishment Macro guys like Sumner simply dismiss his point. Out of frustration Steve kind of lashes out-it's not entirely true that price stabilization is immoral. The use of the term "immoral" is easy for them to simply brush it off-they love to make it seem like those who criticize Macro are simply big in good intentions  but low in economic understanding and logic. Indeed there's no bigger insult they can levy against you than to declare you are 'certainly well intentioned'! It's as if you have to show your totally innocence of good intentions before you are even worth listening too.

           I agree that CB disinflation like we've seen since 1980 is objectionable on both moral and economic-and also certainly social grounds. However, price stability itself isn't really immoral. As Mitchell suggests there are other ways to stabilize prices as the high growth low inflation 60s shows. What should be clear is that at present there is absolutely no threat of inflation-which only rises when demand grows faster than the productive capacity of the economy-just how far away we are from that makes any talk of inflation fears as a bad joke.