We've discussed before the divide between heterodox and mainstream economists and the fact that MS tend to dismiss anyone that fails to accept their conventions-DSGE modeling, microfoundations, etc. We can debate the legitimacy of this-I come down on the side of the heterodox guys mostly.
http://diaryofarepublicanhater.blogspot.com/2013/11/simon-wren-lewis-meainstream-macro-and.html
Stephen Williamson has sure caused a lot of controversy with a post he wrote recently about the Zero Lower Bound and inflation. What's interesting here is that this is not a fight between the MS and HD schools but rather within the MS. Here we have how (MS) economists themselves react when one of their own goes off the reservation. Williamson:
"The situation in Europe is looking more stable, and the private sector is presumably finding new sources of private collateral, all of which reduces the liquidity premium on government debt. Further, we should expect this to continue, for example as the price of real estate and other assets rise. In general, if we think that inflation is being driven by the liquidity premium on government debt at the zero lower bound, then if the Fed keeps the interest rate on reserves where it is for an extended period of time, we should expect less inflation rather than more."
"But that's not the way the Fed is thinking about the problem. What I hear coming out of the mouths of some Fed officials is that: (i) Things are bad in the labor market, and the Fed can do something about that; (ii) inflation is low. Thus, according to various Fed officials, the Fed can kill two birds with one stone, so it should: (a) keep doing QE; (ii) make it clear that it wants to keep the interest rate on reserves at 0.25% for a very long period of time."
"What I hope the discussion above makes clear is that this is a trap for the Fed. There is not much that the Fed can do on its own about the short supply of liquid assets. They can get some action from QE, but the matter is mostly out of their hands, and more QE actually pushes the Fed further from its inflation goal. If the Fed actually wants more inflation, the nominal interest rate on reserves will have to go up. Of course that will lead to some short-term negative effects because of money nonneutralities."
"The Fed is stuck. It is committed to a future path for policy, and going back on that policy would require that people at the top absorb some new ideas, and maybe eat some crow. Not likely to happen. The observation of continued low, or falling, inflation will only confirm the Fed's belief that it is not doing enough, not committed to doing that for a long enough time, or not being convincing enough."
http://diaryofarepublicanhater.blogspot.com/2013/11/simon-wren-lewis-meainstream-macro-and.html
Stephen Williamson has sure caused a lot of controversy with a post he wrote recently about the Zero Lower Bound and inflation. What's interesting here is that this is not a fight between the MS and HD schools but rather within the MS. Here we have how (MS) economists themselves react when one of their own goes off the reservation. Williamson:
"The situation in Europe is looking more stable, and the private sector is presumably finding new sources of private collateral, all of which reduces the liquidity premium on government debt. Further, we should expect this to continue, for example as the price of real estate and other assets rise. In general, if we think that inflation is being driven by the liquidity premium on government debt at the zero lower bound, then if the Fed keeps the interest rate on reserves where it is for an extended period of time, we should expect less inflation rather than more."
"But that's not the way the Fed is thinking about the problem. What I hear coming out of the mouths of some Fed officials is that: (i) Things are bad in the labor market, and the Fed can do something about that; (ii) inflation is low. Thus, according to various Fed officials, the Fed can kill two birds with one stone, so it should: (a) keep doing QE; (ii) make it clear that it wants to keep the interest rate on reserves at 0.25% for a very long period of time."
"What I hope the discussion above makes clear is that this is a trap for the Fed. There is not much that the Fed can do on its own about the short supply of liquid assets. They can get some action from QE, but the matter is mostly out of their hands, and more QE actually pushes the Fed further from its inflation goal. If the Fed actually wants more inflation, the nominal interest rate on reserves will have to go up. Of course that will lead to some short-term negative effects because of money nonneutralities."
"The Fed is stuck. It is committed to a future path for policy, and going back on that policy would require that people at the top absorb some new ideas, and maybe eat some crow. Not likely to happen. The observation of continued low, or falling, inflation will only confirm the Fed's belief that it is not doing enough, not committed to doing that for a long enough time, or not being convincing enough."
Certainly this is a pretty counter intuitive result-he has all kinds of math equations to get here at the top of the page. He has already garnered reproaches by Nick Rowe, Brad Delong,and then Paul Krugman. SW is famous-or infamous-for nothing so much as his one sided feud with Krugman and his constant razzing of him. He really seems to hold Krugman's criticisms of 'modern macro' back in 2009-of 'mistaking beauty for truth'-and routinely razzes him for supposedly letting his politics dictate his economics-many economists accuse Krugman of this.
In response to SW's post Nick Rowe says this:
"My model can identify the edge of a bottomless ZLB cliff. To the north of the edge of that cliff, there can be an equilibrium rate of inflation. To the south of the edge of that cliff, there cannot be an equilibrium rate of inflation, because the cliff is bottomless. Therefore inflation will not go south of that edge. We will never observe a truck going south over the edge of a bottomless cliff, because that can't be an equilibrium, since it is bottomless."
"That's not good enough, but it's the best I can do. That is my reaction on reading Steve Williamson's post."
"I have no (obvious major) problems with Steve's formal model. It is in Steve's interpretation of that formal model where I have a very big problem. If Steve had said 'This model shows that the central bank should not target a rate of inflation south of XYZ, because if it did so the inflation rate would fall over the edge of a bottomless cliff' I would be OK with it. But instead Steve is saying 'This model shows why inflation will not in fact go south of XYZ, because there is no equilibrium inflation rate over the edge of a bottomless cliff'."
"This is not an isolated example. This is very much the same problem I have had with some of the things Narayana Kocherlakota has said. Something somewhere went very deeply wrong with the way macroeconomics is done in some places. I do not know why it went wrong like that."
"This is not about politics or ideology. Explaining everything in terms of politics or ideology is one of those witchcraft explanations that only ignorant people use, who practice witchcraft themselves, and so think everyone else is a witch. I am pretty sure I am more right-wing than Steve is. This is about how we do economics."
I'm not totally sure I buy this claim of Nick's that economics is some pure realm where politics leaves no stain. One point that Simon Wren-Lewis got right is part of the problem with economists is that they like to think of what they do as something like physics.
"I think part of the problem with economics, which is very evident in the way it is taught, is how economists see themselves. (I think Alex Marsh describes this well.) The vision that I think many economists are attached to is that economics is like a physical science. So there is a body of knowledge, which has been accumulated over time in much the same way as the physical sciences have developed. This approach plays down the context in which that knowledge was developed - it may provide a bit of diversion in a lecture, but is not essential. There is certainly no need to worry about the methodology behind the way the discipline works."
If we remember that economics is actually a social science it seems to me they wouldn't make this mistake. As it's a social science it's going to be messy. As to politics, again, the main thing that I've always noticed about SW is that he's obsessed with razzing Krugman and does it constantly. What's interesting though is that the story he tells here-the criticism that Rowe, Delong, and Krugman make is really about how he gets it-is less anti-Krugman than it is anti-Sumner. Let me be clear-this doesn't make it right. However, he's basically agreeing with Krugman-as well as post Keynesians-that the Fed is out of bullets.
That the Fed is 'trapped'-ie, a liquidity trap. While I don't buy that raising interest rates would raise inflation right now, it's certainly a very striking claim to make-QE is actually lowering inflation. It also would explain logically what is going on.
SW differs here from Krugman on explaining why inflation is still above zero-albeit very low. However, his disagreement on substance is even sharper with Sumner than with Krugman. He's differing with Krugman on why there is a liquidity trap. However, Sumner's whole argument for 4 years has been that there is no liquidity trap. Krugman's criticism is mostly around the complaint that SW fails to give his result microfoundations.
For the MS school this is quite a big criticism and SW will especially not enjoy getting it from Krugman. However, what do you say about SW's result if you dispute the need for MF?
P.S. Note that SW doesn't have this out as he most certainly does believe that you have to provide microfoundations so he'll have to explain why he's not guilty of this charge.
