Someone teased me about my recent post
on Zero Lower Bound denial – can any disagreement on theory or evidence now be
labelled by either side as denial? I admit that one of the negative aspects of
blogging (for me at least) is that it can lead to an indecent attraction to
neat catchphrases and rhetorical flourishes. However there was some method in
my madness.
What I take as the characteristic of denial, whether it’s
about climate change or macroeconomics, is that a strong position is taken not
on the merits of the case, but because of a dislike of some implication of accepting the proposition being
denied. So climate change denial would come not from a consideration of the
evidence, but distaste for the idea that it is an externality that requires
government intervention to correct. Evidence that this form of denial exists comes
from the clear correlation between climate change denial and a pro-market
ideology (see
Oreskes and Conway, 2010). In
macroeconomics, demand
denial may also come from dislike of the idea that state intervention
(monetary policy) is required to ensure the aggregate economy stays on its
efficient path, which is why those that keep suggesting our current problems are
not about deficient demand also tend to come from the political right. We could
call this bias or wishful thinking rather than denial, but the key point is
that evidence on the issue appears to have no impact because the source of the
belief lies elsewhere.
In the case of central banks, zero lower bound (ZLB) denial
would be a belief that ‘unconventional’ monetary policy is almost as effective
or reliable as conventional policy not on the merits of the case, but because
the central bank must be seen to be in control. Now no one wants to hear a
pilot tell passengers that they are no longer in control of the plane.
However a better analogy here would be the pilot not telling the co-pilot,
because fiscal policy can also be used to stabilise the economy. In the case of
perhaps some economists, ZLB denial may be due to an aversion to the use of
fiscal demand stabilisation, and hence the need to talk up the effectiveness of
actual or potential monetary policy actions or regimes. But it was the central
bank case that I really had in mind: hence my use of the quote from the
Woodford paper about central bank wishful thinking.
To take the UK example, I have previously discussed (towards
the end of this post)
a speech made by George Osborne that stated that monetary policy was all you
needed for stabilisation and appeared to ignore the ZLB, at the very moment that
UK interest rates hit 0.5%. Now if I had been Governor of the Bank of England
at the time, I would have said in private at least that the world had changed,
and I was no longer sure I could achieve the Bank’s mandate. Perhaps this was
said, and maybe one day we will find out. It was not the stance the Bank took
in public.
Of course, my use of the term denial also signifies that I
believe the idea that unconventional monetary policy is somehow on a par with
fiscal policy in its reliability and effectiveness is fairly weak. I want to
make two points here. First, I think it is important to distinguish between
targets and instruments. My previous post asserted that nominal GDP targets in a world where unconventional monetary
policy was ineffective would only reduce the impact of the ZLB, and not
eliminate it. I think this is a useful case to consider because it helps
clarify ideas: I still read people saying that nominal GDP targets in themselves would mean that large
negative demand shocks would be less likely to take us to the ZLB, and I do not
understand why this is.
Second, the key issue for me is not whether QE will or will
not have some significant effect. My suspicion is that it can, and Woodford’s
baseline case takes too idealised view of financial markets.[1]
However our lack of knowledge about the extent of the deviation from Woodford’s
idealised view mean that these effects appear of an order more uncertain than
the impact of fiscal policy, which is why you have to use the latter, and why
austerity during a recession is foolish.
Which brings me to the recent Bernanke decision. If the FOMC
were ever in denial, they are no longer. What I think is significant about this
decision is that it combines more QE with a suggestion that the Fed may at some
point in the future allow inflation above target. I am often asked how we know
that QE will be temporary – that central banks will claw back the reserves they
have created when the economy recovers – and the easy answer is that they
remain committed to their inflation targets. For central banks that have used
QE, being seen to be totally committed to inflation targets is their way of
showing that they are not permanently monetising government debt. Ironically I wonder
whether QE has made central banks less willing to consider changes in the targeting
regime, because doing so at the same time as printing lots of money would look
too much like the prelude to significant monetisation. In that sense Bernanke
and the FOMC have crossed an important psychological barrier, and hopefully the
world will be better for it.
[1] See
for example Gagnon on
markets in general, and Julian Janssen in a direct comment,
and David Glasner here
in relation to the FOREX market – see also this evidence.
On selling currency to engineer depreciation there is of course the obvious
point that this would not help a global economy at the ZLB, and as a result
would not be received well by other countries.
