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Each year I look at the AER Papers and Proceedings, which comes out in May. It provides short summaries of much of the most important research in the field of economics, presented at the annual convention in January. In recent years there has been almost no discussion of the role of monetary policy in the Great Recession, indeed not much discussion of the Great Recession in any context. The newest issue is a bit better on that measure, but fails in other areas. This is from the intro of a paper by Olivier Blanchard and Daniel Leigh:

In the box published in October, we focused primarily on forecasts made for European economies in early 2010. The reason was simple: A number of large multiyear fiscal consolidation plans were announced then, particularly in Europe, and conditions for larger than-normal multipliers were ripe. First, because of the binding zero lower bound on nominal interest rates, central banks could not cut interest rates to offset the negative short-term effects of a fiscal consolidation on economic activity. [This is from the working paper version.]

The study looked at 26 European countries, including 16 within the eurozone. Obviously there are two huge problems with their intro. Countries at the zero bound can easily offset the effects of fiscal austerity through unconventional monetary stimulus. But far more importantly, the vast majority of the countries in their survey were not in fact at the zero bound. Indeed they were engaged in raising interest rates at the very same time they engaged in fiscal austerity. So the entire study is based on a simple factual error, which the editors somehow overlooked.

And even countries at the zero bound, such as Switzerland, could and did engage in highly effective unconventional monetary stimulus.

It is true that those countries within the eurozone lacked an independent monetary policy. But surely the key issue is how eurozone austerity affected eurozone NGDP as a whole. (And yes, economists should look at NGDP to find multiplier effects, not RGDP.) It doesn’t help the Keynesian cause if fiscal stimulus in Italy pushes Spain and Greece deeper into depression due to monetary offset resulting from the ECB’s 2% inflation obsession.

As far as monetary ineffectiveness, if they read the paper by Romer and Romer in the same issue they would have learned that being at the zero bound is no excuse, central banks have an obligation to use all tools available to meet their legal mandates.

There is little doubt that an overinflated belief in the power of monetary policy has contributed to some major policy errors. . . . In this paper, we present evidence that the opposite belief””an unduly pessimistic view of what monetary policy can accomplish””has been a more important source of policy errors and poor outcomes over the history of the Federal Reserve.

My mood brightened when I read Ryan Avent’s new post:

The comments above illustrate the point perfectly. “Policy hasn’t changed!” they all insist; “Markets just misunderstood us!” But that’s wrong. The market reaction is the policy.

Just as Canadians know much more about the US, than Americans know about Canada, bloggers know much more about academia than academics know about the blogosphere. And with all due respect to the academics (I used to be one) I feel the blogosphere is a decade ahead on policy issues. Academics talk like central banks are out of ammo, while bloggers discuss the unconventional actions that are driving markets in countries like Japan. The real world. Blanchard and Leigh would have gotten massacred in the blogosphere presenting the sloppy argument in their intro.

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This entry was posted on June 28th, 2013 and is filed under Misc., Monetary Policy. You can follow any responses to this entry through the RSS 2.0 feed. You can leave a response or Trackback from your own site.



