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Unfortunately I’m not able to keep up with all the new blogs, but I’m told that Atif Mian and Amir Sufi are brilliant new bloggers who have great ideas on debt. Ryan Avent showed that their expertise on monetary economics is much weaker. Here he discusses a graph they present that showed PCE core inflation has fallen below a 2% trend line since 1999:

Unfortunately, I think they’ve got this wrong in a few ways. First, the Fed doesn’t target core inflation. It targets headline inflation, but it uses core as an indicator because past core inflation is a better predictor of future headline inflation than past headline inflation. So here’s something interesting: take a look at what happens when you track headline inflation (as measured by the price index for personal consumption expenditures) since 2000. Finally everything is clear: the Great Recession was a necessity engineered by the Fed in order to disinflate back to the 2% trend. I’m kidding, of course. In fact, this is the wrong period to consider entirely, because the Fed didn’t adopt an official inflation target until January of 2012.

Why did Mian and Sufi do a study of actual inflation compared to target inflation? Here’s why:

The chart above plots the implied core PCE index if inflation had met its 2% target (red line), and the actual core PCE index (blue line) starting from 1999. The blue line is consistently below the red line, the gap has only diverged further since the Great Recession. The cumulative effect is that today the price level is 4.7% below what it should have been had the Fed achieved its long-run target… What we are witnessing is the limit of what monetary policy alone can do. Sometimes there is a tendency to assume that the Fed can “target” any inflation rate it wishes, or that it can target the overall price level – the so-called nominal GDP targeting. The evidence suggests that the Fed may not be so omnipotent.

So their study was aimed at establishing whether the Fed is able to hit its 2% inflation target. They found it was not, on the basis that core PCE fell 4.7% below trend over 14 years. (Put aside the fact that in the 1970s, before they were inflation targeting, inflation often overshot the target by 4.7% in less than one year.)

If you are a sweet, naive, trusting, honest, idealistic soul, you will naturally assume this story has a happy ending. Ryan corrected the data error. With the correct data the study shows the Fed in fact hit its target almost perfectly in the long run. Great news!! So Mian and Sufi will naturally change their conclusion to fit the actual outcome of the study that they themselves thought provided a window into whether the Fed was able to successfully target inflation. Just as Paul Krugman changed his mind about MM after the results were in from what Paul Krugman himself said would be a 2013 test of MM. They will print a retraction, and change their forthcoming book to show the conclusion that is in fact correct. The Fed can target inflation at 2%. Because we are all scientists, aren’t we? We learn from the results of our tests. I very much hope you are right, but just in case they do not change their conclusions regarding the ability of the Fed to hit a 2% inflation target, let me explain why.

Most economists are not interested in finding the truth; they are interested in using ideas to advance their career. Empirical studies become swords in the battle, to be used when effective and thrown away when they are found useless. I sincerely hope Mian and Sufi are not like most economists. (And to be fair, there have been times when I slip into bad habits as well, so perhaps I should not be throwing stones here.)

Ryan Avent was actually pretty kind to Mian and Sufi, as he overlooked this:

What we are witnessing is the limit of what monetary policy alone can do. Sometimes there is a tendency to assume that the Fed can “target” any inflation rate it wishes, or that it can target the overall price level – the so-called nominal GDP targeting. The evidence suggests that the Fed may not be so omnipotent.

First of all, price level targeting is not at all NGDP targeting. I apologize if this sounds snarky, but they really need to get up to speed on the 2014 blogosphere debate over monetary policy. After everything that has happened you simply cannot still be arguing that monetary policy is ineffective at the zero bound, and use as “evidence” the fact that low interest rates have failed to push the rate of inflation higher. That would be like claiming that the fact that; “more police patrol high crime areas proves that police patrols are ineffective.”

Fiat money central banks can debase their currencies if they chose to. So far as I know none of them really deny this. You can’t be a serious monetary economist in 2014 and claim that a fiat money central bank can’t debase its currency. You can claim there are political barriers. Savers would be upset. Or foreign countries would complain if you depreciated the yen in the forex markets. Or you’d have to buy so many assets that the central bank would be uncomfortable with the size of its balance sheet. Don’t get me wrong, I think even those arguments are wrong, but they are defensible. But in 2014 one simply CANNOT any longer argue that the fact that low rates and QE have been accompanied by low inflation proves central banks are out of ammo. Too much has happened, the debate has moved on.

If you don’t trust me and the MMs, read Ben Bernanke, Michael Woodford, Christina Romer, Bennett McCallum, Milton Friedman, etc, etc.

PS. I promised a friend that I would do a April Fools post. I apologize, but I simply couldn’t think of one that was plausible. Nobody would believe it if I claimed to have converted to MMT. And then I tried to come up with whacky news stories, a la The Onion. Like a story that the IRS ruled that Bitcoins were property, so if you used Bitcoins to buy a Coke from a vending machine, you had to file a tax form for the capital gains on the difference between the 90 cents you paid for the Bitcoin, and the $1.25 is was worth when you bought the Coke. Or that the IRS offered me $10,000 per year to divorce my wife, continue living with her, and continue to tell all our friends that we were married (establishing common law marriage.) But every time I thought up a whacky story like those two, I realized it was true. I feel I live a sort of Groundhog Day film, where every day is April 1st. Where very day someone repeats that low interest rates show easy money doesn’t “work.” Where high interest rate show that money was “tight” during the German hyperinflation. I can’t keep up with reality.

Update: Marcus Nunes also has a good post on Mian and Sufi.

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This entry was posted on April 01st, 2014 and is filed under 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.



