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Here’s Nick Rowe, from a post responding to David Andolfatto:

It makes no sense for economists to talk about the effects of nominal interest rates on inflation (or anything else) without talking about how agents will interpret those changes in nominal interest rates. What is the Bank trying to do when it changes nominal interest rates? What does it mean? Is the Bank trying to change the inflation target? Or trying to defend the existing inflation target? Central banks know this, of course. That’s why they have communications strategies, and announce monetary policy targets.

Exactly.

Andolfatto has an interesting discussion of the recent post by Steve Williamson that triggered a storm of criticism:

So my interpretation of the criticisms I am hearing of Williamson’s paper is that his critics are claiming that he is wrong because his results are inconsistent with the type of models these people are used to working with. It seems to me that the critics should have instead attacked his results and interpretations with empirical facts (or am I too old-fashioned in this regard?). After all, Williamson at least motivated his post with some data (the diagram at the top of this post). And he makes what is potentially a testable prediction (notice the if-then structure of the statement):

In general, if we think that inflation is being driven by the liquidity premium on government debt at the zero lower bound, then if the Fed keeps the interest rate on reserves where it is for an extended period of time, we should expect less inflation rather than more.

Let’s work backwards from the Williamson quote, where the ambiguity of language might cause confusion. If I was told by Nostradamus that the Fed kept the interest rate on reserves at 0.25% for the next 20 years, I’d certainly revise downward my inflation forecast. But that’s because I would assume the causation runs from a lower rate of inflation to a lower policy rate. And that’s because I assume the Fed has a model in its head where raising the policy rate is contractionary.

Regarding empirical evidence, as far as I know all the empirical evidence is that QE has boosted inflation. And yet Andolfatto’s post is entitled:

Is QE lowering the rate of inflation?

And the very first line of the post is:

The answer may be “yes,” according to a new paper by Steve Williamson.

This confuses me, as I had thought it was widely understood that QE has been modestly expansionary for nominal spending and inflation. Recall that markets have responded to QE announcements by changing asset prices in a way that implied higher inflation expectations.

So what is the “data” that Andolfatto refers to when he says that Williamson’s post is motivated by “data?” It’s a simple time series graph showing that the inflation rate has been fairly low since 2009—rising after QE1, and then falling after QE3. But why would that graph have any bearing on the inflationary impact of QE? Surely you’d want to look at market responses to QE announcements, not the actual path of inflation.

As far as I know everyone who seriously follows QE knows that the program is inflationary. The only serious debate is whether it has only a tiny inflationary effect, or whether it has a modest inflationary effect. I can’t imagine anyone claiming it’s been deflationary. For God’s sake the dollar fell by 6 cents against the euro on the day QE1 was announced! Does anyone seriously think a 6 cent depreciation in the dollar is deflationary? So why develop models to explain empirical results that don’t exist? I don’t get it.

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This entry was posted on December 01st, 2013 and is filed under Monetary Theory. 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.



