Winner of the New Statesman SPERI Prize in Political Economy 2016

Thursday 30 October 2014

In praise of macroeconomists (or at least one of them)

This is a title that is sure to spur some angry comments. Didn’t the financial crisis prove that mainstream macroeconomics was hopelessly flawed, that the ‘Great Moderation’ (fifteen or so years of relatively stable inflation and output) that preceded the crisis was a sham, or worse still a cause of the crisis, and basing policy on lots of maths and rational expectations has been totally discredited?

One of the architects of that macroeconomic mainstream is Lars Svensson. He wrote a number of key papers on inflation targeting using lots of maths and rational expectations. Probably for that reason, he was a member of Sweden’s equivalent of the Monetary Policy Committee from 2007 to 2013. By the middle of 2009 Swedish short term interest rates were, like most other places, close to their ‘zero lower bound’ - in this case 0.25%. But in mid 2010 they began to rise again, reaching 2% at the end of 2011. The primary motivation for this continuing rise in rates was a concern that Swedish consumers were taking on too much debt.

Svensson fiercely and publicly opposed these increases, and eventually left the central bank in frustration. He argued that there was still plenty of slack in the economy, and raising rates would be deflationary, so that inflation would fall well below the central bank’s target of 2%. By the end of 2012 inflation had indeed fallen to zero, and since then monthly inflation has more often been negative than positive. It was -0.4% in September. This week the Swedish central bank lowered their interest rate to zero.

OK, so one eminent macroeconomist got a forecast right. Plenty of others get their forecasts wrong. Why the big deal? Suppose you took the statement in my first paragraph seriously. The Great Moderation was about central banks having an explicit forward looking target for inflation, and varying interest rates with the aim of trying to achieve it. So if the success of that policy was a sham or worse, and had been exposed by the financial crisis, a central bank should not worry too much if they abandon it. They should certainly not worry if they deviate from it because of concerns about the financial health of the economy. Which is exactly what the Swedish central bank did.

Now Sweden has negative inflation, and interest rates have come right back to zero. Deviating from what mainstream macroeconomists in general advocate (and what one in particular recommended) has proved a costly mistake. (Svensson estimates it has cost 60,000 jobs.) So maybe the story with the financial crisis is a little more nuanced. Perhaps good monetary policy, aided by the analysis of mainstream New-Keynesian theory, did help bring about the pre-crisis moderation in inflation and output variability. The Achilles heel was that monetary policy lost traction when nominal rates hit zero, but a number of mainstream macroeconomists had discussed the implications of that possibility before it happened in 2009. In the UK at least (and also elsewhere), it was politicians and central bank governors that did not take the consequences of this possibility seriously enough. The financial crisis suggests that what was missing was better financial regulation (including macroprudential monetary policy tools), rather than a need to rewrite how we set interest rates.

I am certainly not claiming that mainstream macroeconomics is without fault, as regular readers will know (e.g.) However it is important to recognise the achievements of macroeconomics as well as its faults. If we fail to do that, then central banks can start doing foolish things, with large costs in terms of the welfare of its country’s citizens. And while it might appear unseemly to occasionally blow one’s own profession’s trumpet, I suspect no one else is going to. 


  1. The problem is not so much that "monetary policy lost traction when nominal rates hit zero", but that rates had to hit zero because of a financial crisis that inflation targeting could not see coming. You're only looking at how macroeconomics could deal with the crisis once it happened, rather than the boom-bust period as whole.

    1. No he's not, however, let's not fail to recognize Keynes contribution to deal with trade cycles back in '36. ....that would be chapter 22

  2. Yep. And the hardest thing to explain to non-macroeconomists is that if you are scared of low interest rates the last thing you want to do is have the central bank raise interest rates. The "let's raise interest rates because low interest rates are bad for financial stability" argument has proved to be a disaster even under its own terms.

    1. It was brilliant MIT macroeconomists who advised financial crisis hit Asian economists during the Great Moderation to do exactly that. It was historians, heterodox economists and area specialists who were advising against it - and not being listened to.

    2. Sorry that was financial crisis hit Asian economies (1990s) - a reference to the IMF's SAPs.

    3. Sweden has an inflation target, flexible exchange rates, and (AFAIK) borrows in its own currency. That makes it macroeconomically very different from those Asian economies in the 1990's.

    4. anonymous: who are the brilliant - i assume with nobels - MIT macro economist who suggested inceasing interest rates?

    5. As a non economist I admit I find the deflation discussion confusing.
      There seems to be too much debt strangling the economy, let's therefore lower interest rates, to let the economy take on even more debt. Doesn't sound logical to me, what part do I not understand?
      Japan tried deleveraging the debt bubble with fiscal and monetary policy, and they still struggle with deflation and high public debt. They did dig themselves into a hole, and whatever they do, the hole seems to get deeper.
      Today the BoJ governor announced new QE with as objective (in his words):
      “It’s important for the BOJ to strongly commit to achieving its price target to get its price target firmly embedded in people’s mindset.
      “It won’t do much good in trying to shake off the public’s deflation mindset if you just say inflation will reach 2 percent some day. We expanded QQE to pre-empt risks.”

      What exactly is he trying to achieve? That people will start spending because they somehow think inflation will rise? Is there any empiric evidence that underpins such a change in behavior?
      It seems to me that if you have an aging society, people will save more and spend less, whatever you do. And if you scare people their savings will be worth less, the logical reaction would be to spend even less. That seems rational behavior to me. Again, what part am I missing here?

    6. Absolutely. And even more importantly than that they are fundamentally economically very different to each other. Nevertheless when the orthodoxy was very strong and mathematical REH model based analysis was considered "sophisticated and rigorous" their advice to these economies, whose financial difficulties were largely created by financial deregulation know what? You guessed it. Further deregulation. (If people were historically literate or had read heterodox economists like Minsky this would not have happened.) It was very brave people like Mahathir , however who did not use gimmicky models but understood his own country and economy very well - combined with common sense - who put in place capital controls. But he was really chastised by the profession and the chattering classes for doing this and being "economically illiterate".

      And you know what what the IMF even advises capital controls now. Could you have imagined that in 1997?

      I think macro-economists put too much emphasis on the advantages in having your own currency. The scope for implementing a desired expansionary macro-policy is limited when you have twin deficits - trade and government, you are trade dependent and you have a structural trade problem, and you foreign capital dependent/ with both a private and public sector deficit.

      The historical lesson from the Asian Financial Crisis was that you need a foreign exchange buffer. The scope for devaluation is limited. International trade, especially for East Asia, is conducted in US dollars, and if you are dependent on strategic imports of fuels, inputs and food you have to earn the currency to pay for it. If things turn against you foreign portfolio investors are not compassionate people. Countries that really have problems (Africa, Middle East, South America, Greece etc) are essentially countries which do not have the value added exports to pay for the imports and perpetually face a structural terms of trade problem. Pre Euro- Greece was essentially a country that basically relied on devaluation and inflation to get its way out of immediate problems. But it could never solve its industrial structural problem (exports of Olive Oil to pay for fuels and expensive German machinery). And as bad as things are now, people there still want a hard currency.

      It would be good if Macro-economists studies linguistics like a lot of other social sciences - reflecting the influence of Derrida for example. What does it mean when a currency has currency? Why do we use that word? Who came up with it, when, and why? What would it mean if a currency did not have currency?

      So in short, the mistakes made in Asian crisis were not necessarily about implementing austerity policies after the crisis. (Although the shock-therapy treatment was most likely wrong.) The problem was the tragedy in having to implement policies that stabilised the exchange rate due to a dogma and a theory based on comparative advantage and other such classical and neo-classical constructs advocated the liberalisation of capital flows.

    7. The above (Anon 07.32) is a response to Nick Rowe (04.07).

    8. Rob Sol

      "Let me add that companies with substantial foreign currency debts are likely to suffer far more from a long, steep slide in the value of their domestic currency than from a temporary rise in domestic interest rates. Moreover, when interest rate action is delayed, confidence continues to erode. Thus, the increase in interest rates needed to stabilize the situation is likely to be far larger than if decisive action had been taken at the outset. Indeed, the reluctance to tighten interest rates in a determined way at the beginning has been one of the factors perpetuating the crisis. Higher interest rates should also encourage the corporate sector to restructure its financing away"

      Stanley Fischer.

      It was not just Fischer, you are talking about the entire IMF economics department, heavily linked with MIT, and most New Keynesian heavyweights. Also remember the letter from Stiglitz to Rogoff?

      I suggest you read all of this

      The Moral Hazard arguments in particular might make you cringe.

  3. Very good, clarifying. Stevenson is a mainstream ec, but always with an eye for balance sheet problems.

  4. I tend to side with you in argument over overhauling economics. Here's a macroeconomist who got it right, I agree.

    However I did like what DeLong said on a panel with Jeff Madrick recently about how we need a new grammar in which to discuss markets. The new classicals or classicists with their worship of markets needs to be purged. They've caused a lot of mischief and heartbreak.

  5. [Perlasca]
    When I studied economics I was startled by the introversion of the scientific discipline and its absurd lack of interest for the real world out there. Many economic theories or ideas seemed to be purely logical/mathematical constructs based on ludicrous assumptions, their advocates being in constant clinch with fans of other purely logical/mathematical constructs based on a slightly different set of ludicrous assumptions; with a shared preference to not make their hands dirty with actual data. It did at times feel like studying theology.

    On a not-so-different note, a friend from the ECB once told me they'd had extremely sophisticated models for modelling and forecasting the real economy, but those did not incorporate any element of the financial system (or the interaction between the real economy and the financial system) up until 2009 or 2010. How crazy is that?

    I think economics needs to get much more humble and inductive in nature to be taken seriously again. Effectively it would need to do away with its 'lebenslüge' of being an objective, 'real' science like physics.

    One comment on Svensson and Sweden. It would seem that when there's a discussion in a central bank if to raise interest rates to deflate an asset bubble, then arguing against that with there being slack in the economy is not very relevant. That point would seem relevant when interest is to be raised for fear of accelerating consumer price inflation.
    Anyway, I have ample anecdotal evidence saying that housing price inflation in Sweden has reached levels hardly bearable to many, also I seem to remember articles from the last couple of months discussing the possibility of a real estate price bubble in Scandinavia. I think the rating agencies have raised this too as a major risk to financial stability in these countries.
    So while Svensson's advice may have been great all along, I think proving this would require much more thorough reasoning than what is displayed in this blogpost.

    1. I think the problem right now is that academic macroeconomics is not being taken seriously enough, and not that it is being taken too seriously. See not just Sweden, but the Eurozone and austerity.

  6. Was it really rational expectations models behind Svenssons intuition of "getting it right". Besides surely many heterodox and other economists also got it right about the outcome of the Great Moderation, especially those who were historically literate and literate in the history of the discipline.

    1. Svensson worked on Japan. It was knowing about Japan, even just a little bit (eg. compared with Japanese economic historians who work in Japanese) rather than the REH (an irrelevant, and perhaps even counter-productive, gadgetry additive), that was more likely to be behind his position regarding monetary responses to deflation.

    2. I think you should not discount the influence of rational expectations on the desirability of inflation targeting. If inflation expectations were just based on past inflation, there is much less point in having a commitment to an inflation target.

    3. I have always wondered why inflation targets are pretty much everywhere set at 2%. Is this a calculated value based on good macroeconomics, or do you think they just follow each other blindly?

    4. Here's a good answer from a neoclassical-leaning Keynesian like Mr. Wren-Lewis: Paul Krugman: The Four Percent Solution:

      "The point is that the conventional 2 percent target is a prejudice, nothing more; it once rested to some extent on studies suggesting that 2 percent was enough to make the zero lower bound a non-problem, but we now know how utterly wrong that view was; so we’re left with a target that’s considered respectable because it’s what all the respectable people say, and is what all the respectable people say because it’s considered respectable.

      "What do we want? Four percent! When do we want it? Now!"

    5. So I am neoclassical leaning!? This post is about focusing monetary policy on the output gap and inflation, rather than the financial sector. 2%, or 4%, is a separate issue.

    6. Isn't New Keynesian the integration of Keynesian economics with neoclassical economics?

      Anyways, these days even neoclassical economists deny they are "neoclassical", "neoliberal", "free-market", or even on the right-side of the economic spectrum. After 35 years of failed policy recommendations, it's not hard to see why they hide in the shadows.

    7. "After 35 years of failed policy recommendations, it's not hard to see why they hide in the shadows."

      Ref Anon 09.12

      Basically they ditched Keynes or diluted it with irrelevance like sticky prices (the GT was a policy prescription for a demand expansion in a price variable economy), created artificial constructs like NAIRU, fell in thrall to the marvels and Maths and Computer model technology and created a lot of nonsense to accomodate both, drove people with humanities backgrounds out of the discipline leaving it short of critical reasoning, narrow minded and unengaged with other disciplines. They also forgot the lessons of history, became ignorant of the history of the discipline and it left a construct unable to resist powerful interests and it once again returned to its British Empire pre-Keynesian ideological construct. (Limited resources and unlimited wants, that is budget constraints and indifference curves, that is, people are greedy and you must not get in the way of markets.)

    8. Thanks for the info. From my impression of history, monetarism and inflation targeting have contributed greatly to skyrocketing inequality and debt, both private and public. The Great Moderation produced successive bubble economies that crashed in the Great Recession. If we do manage a recovery (Japan has been stuck in a slump for 20 years) it will almost certainly be another bubble which will lead to another collapse.

      So when it comes time to pick up the pieces, these fake liberal closet Friedmanites will be standing in the way, offering an alternative which is the very same ideology that caused all the mess in the first place. Real Keynesian economics is trickle-up. All segments of society benefiting from GDP and productivity growth. The neoclassical ideologues believe rent-seeking plutocrats own the economy because that's what the market gods have determined. Market fundamentalism is certainly dismal, but it doesn't remotely resemble a science. The economy is meant to serve and benefit democratic society, not enslave it.

      BTW, do you have any more of these references? If so please send me a link, or email me at:

  7. But surely Svensson wasn't the only macroeconomist on the Swedish MPC ? Isn't this a case of macroeconomists disagreeing, rather than the bank ignoring macroeconomists ?

    1. I do not think so. From what I have seen academic economists are pretty clear that you should use macroprudential tools to deal with issues like housing booms, and focus interest rates on inflation/demand stabilisation. The push to do otherwise has come from central banks.

    2. @Simon - it would be interesting if you could elaborate further on that point.

    3. While I certainly agree with you I have great sympathy for the conundrum the Riksbank has found themselves in. House price growth in Sweden has indeed been extremely strong and bubble like the last couple of years. However it was not growing quickly in mid 2010, in fact prices was flat or falling for the enitre period in which the Riksbank increased interest rates.

    4. If banks stick to sound lending rules then there would be no bubble.

  8. I see the BBC has notionally covered this (no correspondent name on article), given its silence on the Swedish economy hitherto (28 October 2014 'Sweden cuts interest rates to zero').

    I also see that on the BBC 31 October 2014 'Government to pay off some of WW1 debt' has just appeared, where:

    "The Treasury said it will redeem £218m of the £2bn of debt outstanding from the 1914-18 war. The chancellor George Osborne is able to do this because interest rates are currently lower than the 4% interest on the debt. It is the first payment of its kind for 67 years. In addition to re-financing the war bonds, the government will also redeem debt stretching back to the eighteenth century...The bonds that Mr Osborne have acquired instead have a much lower interest rate."

    You would think there is a macroeconomic lesson in this, but I can't quite put my Keynesian finger on it.

  9. The Great Moderation is a farce because its apparent success was founded on two successive bubble economic cycles — the dot com bubble and the housing/derivatives bubble — that crashed and burned in the Great Recession (which we have yet to recover from 6 years and counting.)

    Calling this a success story is like saying smoking cigarettes moderated a person's weight, but the lung cancer he suffered from afterwards was completely unrelated.

    Sweden's central bank and the ECB caused a double-dip recession with an ideological interpretation of inflation targeting. Other countries, like the US, the UK, and Canada, have dual-mandate inflation targeting (whether explicit or implicit) and didn't make the same blunder.

    As Joseph Stiglitz points out in "Inequality," the obsession with inflation benefits bankers and bondholders at the expense of workers and economic growth. The idea an arbitrary 2% inflation target has been good for the economy is completely absurd. All evidence is to the contrary.

    We need more democratic influence over how the economy is managed — like during the successful post-war Keynesian era. Bankers pretending to be technocrats with self-serving economic doctrine are causing economic instability and rising inequality. None of this will change unless we reverse course. It will only get worse.

    1. So what do you suggest about those two booms - that interest rates should have been raised to prevent them? Sweden's central bank and the ECB have made things worse by not trying to hit their inflation target! The UK does not have a dual mandate - even implicitly. Do you really thinking Republicans running the Fed would be an improvement!

    2. "So what do you suggest about those two booms - that interest rates should have been raised to prevent them?"

      Actually the Fed raised interest rates before both bubbles broke. But I believe in cooperative inflation targeting as opposed to a monetary sledge hammer. There are four ways to keep inflationary asset bubbles under control with direct targeting.

      First is regulatory. Margin requirements can be raised on stock bubbles. Down payments can be raised on housing bubbles. Also minimums can be imposed on mortgage payments: pay as if mortgage rate is 5% even though its 2.4%. (Builds up equity faster, instead of seeing it disappear when housing bubble deflates.)

      Second is taxation. A variable rate financial transaction tax can be raised to dampen speculation. A variable rate VAT on houses and condos can also manage inflation in that sector.

      Third is stern warnings from the central bank. If central bankers warn about inflation in asset bubbles that will make people think twice before getting in.

      Fourth is an overall regulatory framework that separates commercial banking from investment banking, breaks up too-big-to-fail institutions, regulates derivatives and the shadow banking sector, reigns in the synthetic asset casino, etc. Joseph Stiglitz goes into great detail in "Freefall" and "Inequality".

    3. "Sweden's central bank and the ECB have made things worse by not trying to hit their inflation target! "

      Well they raised interest rates to fend off imported supply-shock inflation in 2011 which put the rate over 3%. If they used the core rate it would've told a different story. (I remember reading Krugman saying something like the core rate is related to inflation expectations.)

      Sweden is an interesting test case. They had 6.5% GDP growth in 2010. They began raising interest rates in mid 2010. It only took a 2% rate to kill their recovery. The Fed and Bank of England are eager to raise rates before core inflation hits the 3% upper limit. They could fall into the same trap.

      "The UK does not have a dual mandate - even implicitly. "

      Sure it does. Read Carney in this article:

      'Securing the recovery is like making it through the qualifying rounds of the World Cup — it's a real achievement, but not the end goal. The prize in the economy is sustained and prolonged growth."

      Why talk about unemployment and growth as a goal if they are not part of an implicit mandate?

      "Do you really thinking Republicans running the Fed would be an improvement!"

      They were running the Fed when Greenspan and Bernanke were in charge. Greenspan recommended tax cuts, opposed regulation of derivatives and the shadow banking sector. Bernanke bought up toxic derivatives for 100 cents on the dollar and tried to hide it from the public.

      The central bank must balance inflation with jobs and economic growth. The low arbitrary 2% target favors bondholders over workers, savers over borrowers. It has also made a train wreck of the Western economy. A real independent central bank will not be of the bankers, by the bankers, for the bankers.

    4. Your first reply agrees with what I wrote - macroprudential tools look after financial bubbles, not interest rates. That was Svensson's point, and the whole point of my post!

      Recognising that the transmission mechanism works through the output gap is not having a dual mandate. A dual mandate is where closing the output gap is on an equal footing with the inflation target. The Fed has that, and the UK does not, and I have argued that UK policy would be improved if it did:

      Sweden kept interest rates high because of fears about consumer debt and housing - just read their own accounts.

      Labels can be a substitute for research and thought, which is why I do not like them.

    5. The ECB didn't raise interest rates to moderate a housing bubble. (The IMF has given similar bad advice to Canada.) They were acting on a spike of inflation in 2011 that put the rate above the 3% limit of the 2% target.

      Of course, these literal interpretations of inflation targeting can also have a political agenda as they did in Canada in the early 1990s under John Crow. His hawkish interpretation of the inflation target caused Canada's debt/GDP to hit 100%. That forced a number of neoliberal reforms on the successive "Liberal" government: cuts to spending, cuts to unemployment insurance benefits and cuts to corporate taxes.

      Canada has single-mandate inflation targeting. Yet our present BoC governor Stephen Poloz is more dovish than Janet Yellin on a time table for raising interest rates. No BoC governor since Crow (including Mark Carney) has put the economy on inflation-targeting auto-pilot. They weight the effect interest rates will have on unemployment and GDP growth as well as inflation.

      Considering a dual mandate has an inherent conflict: the central bank must choose low inflation at the cost of lower employment and slower GDP growth (or vice versa,) the Fed really doesn't have a dual mandate. They have chosen low inflation over output (the Great Moderation) by choosing a low inflexible 2% inflation target that doesn't even account for all the time spent well below target.

  10. Keep up the good work, and don't let the nazties grind you down.
    Academic economics is always going to be seen as left of centre, because economics is down to the best way for the common good. The alternative is barbarism and each for their own.

    1. Unfortunately, inflation targeting, at least at 2%, is not for the common good. It is for the good of bankers and bondholders at the expense of everyone else. Read Nobel laureate Joseph Stiglitz's book "Inequality". It tells it like it is!

    2. Targetting inflation at 2, 3 or 4 percent makes very little difference if not for the space it allows in case of grave crises.

      And, as far as macroeconomic policy is concerned, recent events shows that making policy an electoral issue does not lead to good decisions. Politicians faced the best case for fiscal policy and most of them did the exact opposite of what economists recommanded, save for a few. You want that sort of people to run central banks too?

      Our current woes owes a lot to the fact that politicians prefered to listen to a handful of nuts and vested interests than to listen to mainstream macroeconomists. I must give it to professor Wren-Lewis: they had valuable, clear advice that was overlooked to the point where almost the opposite of these tips has been followed.

      And, while this is not directed to you, I must say it. I read countless times that the failure to forecast a crisis proves macroeconomics is wrong... Just to say it, but there's a reason why we call our fancy models DSGE: in these, chocs are modelled as unpredictable -- hence the word stochastic. We don't forecast them and, for this very reason, we can't be wrong about it. When you test models, you test its predictions and when they don't match reality, something is wrong with it; but you can't judge it on the grounds of what it doesnt say.

    3. "Targetting inflation at 2, 3 or 4 percent makes very little difference if not for the space it allows in case of grave crises."

      According to your flaky ideology. According to the facts, busting inflation down to 2% meant higher interest rates, higher unemployment, faster falling real earnings, higher government debt, deeper recessions than would've been incurred if the target was 3% or 4%.

  11. "Academic economics is always going to be seen as left of centre, because economics is down to the best way for the common good. The alternative is barbarism and each for their own."

    More than any other discipline, economics, with its micro-economic foundations, rationalises individual self-interest rather than trying to understand human interaction and how civilised societies really work.

    1. Great insight. What's the difference between economists and psychologists? Psychologists actually test their hypotheses on human behavior.

  12. ''As Joseph Stiglitz points out in "Inequality," the obsession with inflation benefits bankers and bondholders at the expense of workers and economic growth. The idea an arbitrary 2% inflation target has been good for the economy is completely absurd. All evidence is to the contrary.''

    When inflation rises, so do bond yields and stocks. How does this harm bankers, bondholders (in the long run) or investors in general?
    It seems to me that the countries in the world that are considered most hawkish about inflation, also do have the least inequality. Sweden would be an example.

    1. I'll let Ron Waller answer his own way, but a lot of it has to do with relative rather than absolute wealth. Bond holders want to keep capital scarce, it maintains its value, especially vv everyone else. For the same reason they want to keep worker's wages down.

    2. First, there is no perfect relationship between inflation and the return on bonds, let alone stocks. The central bank has the greatest influence on rate of return on bonds. Real interest rates were actually negative in the mid-1970s.

      Second, looking at the inflation data, it would appear Sweden's central bank adopted a 2% inflation target during the 1990s like most other developed countries. Sweden has low inequality because of stronger progressive taxation and government spending on public benefits.

      Third, the way a central bank controls rising inflation is by raising interest rates which kills GDP growth and raises unemployment. The lower the inflation target the higher the real interest rate and the harder workers will be hit. The reason real wages stopped rising along with GDP-per-capita beginning in the late 1970s is because of inflation-fighting monetary policy.

      If central banks had adopted a 3% or 4% target and managed asset bubbles (with regulations) the economy wouldn't have collapsed. It's also more effective to dampen inflation using fiscal and regulatory measures along with monetary policy. As stimulus, monetary policy is trickle-down supply side — not very effective. As inflation control, monetary policy raises real interest rates which means people, businesses and governments pay more interest on their debts. That means bondholders get free money at everyone else's expense.

    3. Thanks for the reply.
      I agree with preventing asset bubbles with regulation, I also agree that progressive tax is good against inequality, but I don't understand the supposed benefits of higher inflation.

      ''The reason real wages stopped rising along with GDP-per-capita beginning in the late 1970s is because of inflation-fighting monetary policy. ''

      correlation doesn't mean causation. And the 70s was the times with high inflation and high unemployment in the Western world.
      The fact that wages don't rise anymore can also be caused by globalization, with hundreds of millions low wage workers entering the global economy.
      Higher inflation has also negatives, higher costs for ordinary people are not necessarily compensated by higher wages. In other words, higher inflation can erode livings standards.
      The main benefit of higher inflation to me seems to be it decreases debt value, and therefore can be used against a debt overhang (like now). But a better way would have been for households to not get so deeply indebted in the first place.
      The blame I put on economists is that they hardly warned against high private debt levels (at least not before the crisis) or claimed you can't predict housing bubbles. That is the main reason why we are in trouble.
      And regarding unemployment: there are other ways to fight unemployment, like they do in countries with mixed economies like Sweden, that are more effective than using higher inflation targets.

      ''As inflation control, monetary policy raises real interest rates which means people, businesses and governments pay more interest on their debts. That means bondholders get free money at everyone else's expense.''

      I would think you need to look at nominal rate of return.
      Low interest rates pumps up asset values, but the effective rate of return or risk premium above risk free assets investors in stocks receive is still the same. Bonds is a different story because of monetary policy, I don't see why government bond holders should be happy with QE and ultra low interest rates, as their rate of return is close to zero.

  13. Seems that the commentators to this post are not up to date with the facts about Sweden and growth. Since the recession in 2009 Sweden has had the following growth;
    2010-6.6%, 2011-2.9%, 2012-0.9%, 2013-1.6% and the IMF forecast for 2014 is 2.1%. This means that the growth trajectory and GDP compared to peak in 2007 is on par with the United States. To compare Sweden and the Euro zone and conclude that the countries suffer from the same policy mistakes shows in my view a complete lack of understanding. Swedens record on employment is also better than the United States where the number of employed persons is bigger to date than during the 2007 peak in the economy.

  14. Futher to Anon 9.09, 07.32 and Nick Rowe 04.07

    The latest IMF report suggests its response to the Asia Financial Crisis was entirely wrong and now advises:

    "Flexibility in targets and approaches (including direct budget support and judicious use of capital and exchange controls)."

    Thankfully they have now abandoned privatisations, deregulation, freedom of movement of capital (even though this was the immediate cause of the crisis) and austerity with the overall aim to exchange rates during a crisis. Basically the whole of their old (1978-2012) ideology is in the dustbin.

    Now it is the turn for a hard look at "New Keynesian" economic theory and its senior protagonists which allowed it to happen.


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