Their argument is that the standard IS-LM model leads to the conclusion you should not raise rates in the present environment, so no move away from orthodoxy is necessary to reach this conclusion. I think the issue is more on the supply side than the demand side. If I believed strongly in the vertical long run Phillips curve with a NAIRU, or natural rate of unemployment, around five percent and in inflation expectations responsiveness to a heated up labor market, I would see a reasonable case for the monetary tightening that has taken place.

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Since I am not sure of anything about the Phillips curve and inflation is well below target, I come down against tightening. The disagreement does, it seems to me, come down to the Fed’s attachment to the standard Phillips curve mode of thought. My disagreement is reinforced by other judgmental aspects that are outside of the standard model used within the Fed. These include hysteresis effects, the possibility of secular stagnation, and the asymmetric consequences of policy errors.

I am sure Paul and Brad are right that a desire to be “sound” also influences policy. I am not nearly as hostile to this as Paul. I think maintaining confidence is an important part of the art of policy. A good example of where market thought is I think right and simple model based thought is, I think, dangerously wrong is Paul’s own Mundell-Fleming lecture on confidence crises in countries that have their own currencies. Paul asserts that a damaging confidence crisis in a liquidity trap country without large foreign debts is impossible, because if one developed the currency would depreciate generating an export surge.

Paul is certainly correct in his model, but I doubt that he is in fact. Once account is taken of the impact of a currency collapse on consumers’ real incomes, on their expectations, and especially on the risk premium associated with domestic asset values, it is easy to understand how monetary and fiscal policymakers who lose confidence and trust see their real economies deteriorate, as Olivier Blanchard and his colleagues have recently demonstrated. Paul may be right that we have few examples of crises of this kind, but if so, this is perhaps because central banks do not in general follow his precepts.