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In my study of the Great Depression, I argued that the Depression could be seen as resulting from governments doing too little, or too much. In a laissez-faire world the Great Depression would not have happened, nor would it have happened if governments took as much responsibility for AD stabilization as they do today (and even that’s a really low bar!)

In blog posts on the Great Banking Crisis I argued it wouldn’t have happened if the government had done much more regulation, or much less regulation. If they had abolished FDIC, TBTF, and the GSEs, banks would have taken far smaller risks. But given they didn’t abolish those generators of moral hazard; they should have banned mortgages with less than 20% downpayments made with funds from FDIC-insured banks.

Tyler Cowen quotes this comment from Ryan Avent:

The euro-zone must recognise that it is the failure to build appropriate euro-zone-wide institutions””equal in scope to the considerations and resources of the central bank””that is contributing to soaring yields around the periphery and creating the illusion of the need for dramatic austerity in places that could do without it.

Maybe, but I’d argue exactly the reverse. It was the success in building inappropriate euro-wide institutions, specifically a central bank, that created the crisis. Ryan might agree, but then the question becomes how to get out of this mess. Matt Yglesias says the solution is easy. I only see one easy solution, monetary stimulus. And even that won’t really solve the problem, just make it much smaller. The other solutions, breaking up the euro or fiscal union (i.e. much more centralization or much less), are currently politically impossible. Of course, one must be careful in dismissing ideas as politically infeasible, as the current path of Europe is likely unsustainable, which means in the future they may well adopt a policy that is currently “politically infeasible.”

After commenting on Avent, Tyler discussed the ECB, and then made the following observation:

On top of all that, arguably the deflationary pressures in Greece, and possibly Spain, are already past the point of control from the ECB side, given the ongoing collapse in private lending.

The most recent inflation rate in Greece is 1.7%, whereas Spain has 1.9% inflation. I don’t know about you, but I find those figures to be astounding. That’s not deflation, and yet Tyler’s clearly right that they are being buffeted by powerful deflationary forces. I’d make several observations:

1. This shows the poverty of our language. Economics lacks a term for falling NGDP, even though falling NGDP is arguably the single most important concept in all of macro, indeed the cause of the Great Depression. So we call it “deflation” which is actually an entirely different concept. I wouldn’t be the first to find connections between the poverty of our language and the poverty of our thinking.

2. Through experience I’ve learned that whenever a data point seems way off, there are probably multiple reasons. Thus Greece and Spain probably have less price level flexibility due to structural rigidities in their economies. And the inflation might be partly due to special factors like increased VAT or higher oil prices. Nonetheless, these sorts of depressions would have been associated with falling prices in the 1930s, so it’s not your grandfather’s business cycle.

Tyler has a new post:

Recently accepted wage cut for new project, ngdp will go up not down. I am helping to manufacture ngdp, people get with the program. What did *you* do for nominal gdp today? Just asking.

In a recent post I argued that falling wages were a really bad sign. Some commenters thought I opposed wage cuts. Just the reverse, if we are stupid enough to let NGDP fall, wage cuts are an excellent idea. I want wage flexibility at the micro level, and a monetary policy that produces stable wage growth at the macro level. If the central bank targets inflation, wage cuts will even boost NGDP.

And what did I do for NGDP today? I used blogging to press more FOMC members to support NGDP targeting. Thanks for asking.

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This entry was posted on May 03rd, 2012 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.



