Rajat directed me to a post by Miles Kimball, entitled “Pro Gauti Eggertsson”. Over at Econlog I discussed one paragraph from his post. Here I’ll discuss another:
Gauti has also taken a lead in applying the same principles he applied to the Great Depression to the Great Recession. A hallmark of his papers is very careful discussion of how they relate to key controversies in the academic literature, and indeed, they go to the heart of some of the biggest issues in the study of business cycles and stabilization policy. Price flexibility and advance anticipation of inflation are often said to be the keys to monetary policy having no real effect on the economy. But along with Saroj Bhattarai and Raphael Schoenle, Gauti argues in “Is Increased Price Flexibility Stabilizing? Redux” that, short of perfect price flexibility, greater price flexibility is likely to be destabilizing. This idea has a long history, but had not been fully addressed within the context of Dynamic New Keynesian models without investment. Along with Marc Giannoni, Gauti argues in “The Inflation Output Trade-Off Revisited” that contrary to the idea that anticipated inflation does not matter, it can matter greatly when raising expected inflation loosens the zero lower bound. The argument is made in a very elegant and clear way.
In my view, higher expected inflation is not expansionary, holding NGDP expectations constant. Thus if NGDP is expected to grow at 5%, then higher inflation is associated with lower real GDP growth. The proponents of the alternative view would claim that I’m missing the point, that higher inflation expectations will cause higher NGDP growth expectations. I don’t think that’s right. A more expansionary monetary policy may cause both inflation and NGDP growth expectations to rise. On the other hand, supply shocks can affect inflation expectations without impacting NGDP expectations. Never reason from a price level change—always reason from a NGDP growth change.
In 1929-32, President Hoover discouraged companies from cutting wages. This made the Great Contraction of 1929-32 even worse than it otherwise would have been. In contrast, wages were cut sharply during the severe deflation of 1920-21. Some free market purists make too much of this comparison, suggesting that tight money is not a problem if the government allows wages to be flexible. Not true, the 1921 depression was quite deep.
But also pretty short. And one reason it was so short is that in 1921 and 1922, wages adjusted quickly to the lower price level. If Hoover (and FDR) had allowed wages to adjust in the 1930s, the Great Depression would have been much shorter.
Stable NGDP growth and non-intervention in wages and prices, these policies work together like a hand and glove.
PS. I encourage people to read Giles Wilkes’s new piece on blogging. Wilkes was nice enough to include me in with a group of much more deserving bloggers. I was also pleased to see him talk about Steve Waldman, a wonderful blogger and also a good example of how the blogosphere is a meritocracy, where professional credentials do not matter.
PPS. Trump? Still . . . an . . . idiot.
HT: Tyler Cowen, Tom Brown