LAST week central bankers from around the world gathered in Jackson Hole, Wyoming for the Kansas City Fed's annual economic shindig. Among the papers presented was one by Robert Hall, on "routes into and out of the zero lower bound". Paul Krugman has a useful write-up in which he describes my sense of the paper perfectly: all over the place, but carrying the promise of big potential insight.

Mr Hall is attempting to explain continued high unemployment, and his paper proceeds in three broad steps. First, he explains the basic (and common) macro framework he's using. There is a level of the real interest rate that should clear product markets despite a fall in demand—that would make sure available resources, including people, are being used effectively—but the zero lower bound has prevented many rich economies from pushing their policy rates down to the market-clearing level. The nominal policy rate can't go below zero (because negative rates would simply lead people to move into cash). And the real interest rate (which is the nominal rate minus the rate of inflation) therefore hits a floor at a level close to the negative of the central bank's inflation target. Throughout America's recovery, for instance, the real policy rate has never much gone below -2%, while Mr Hall estimates that a rate of -4% is necessary to clear markets.

Mr Hall next pivots to another interesting discussion, in which he attempts to explain the mechanics through which falling demand translates into high unemployment. He, like other macroeconomic theorists, starts with a matching model in which a firm decides to hire when the present discounted value of the future benefits of the hire are above some critical threshold. The trick, then, is to explain how falling demand affects those factors. Mr Hall's clever solution is to focus not on changes in the flow of benefits but in the discount rate. When a demand shock hits, firms grow antsy about making risky investments in human capital as well as in physical capital. Mr Hall looks at stock market moves to see how discount rates vary across the business cycle. When times are bad the discount rate is really high, and Mr Hall reckons a similar discount rate should apply to the job calculation. He puts together a nifty chart that shows a very tight match between moves in the Wilshire stock index and in an index of job value. This line of thought is intriguing, and I hope others follow up on it. As Mr Hall says:

[E]vents that trigger a rise in financial discounts, such as a financial crisis, will lower job values substantially, causing a corresponding increase in unemployment and decline in output. In other words, there is a direct linkage from financial disturbances, not just a response operating through a decline in the demand for output.

The third pillar of the piece is a series of comments on the relationship between inflation and economic slack. Inflation has not behaved quite as one might have expected during the downturn; one might have assumed that so much excess unemployment would lead to sharp declines in inflation and perhaps actual deflation. This has not occurred, leading Mr Hall to wonder whether everything we know about Phillips Curves might not be wrong. He presents a few different stories concerning what might be happening. Stable inflation could be an equilibrium, in the sense that no employer sees any advantage to lowering prices to undercut competition. Or the rise in the discount rate could effectively mean a reduction in the economy's supply potential. That, in turn, would imply that there isn't much slack, and so the combination of high unemployment and stable inflation is no puzzle at all. But Mr Hall also reckons central banks should do what they can to try and commit to higher future inflation and certainly shouldn't withdraw support for the economy too soon.

It seems to me that the inflation question is the really critical issue. As Mr Krugman notes, most measures of financial market stress or risk premiums suggest things are mostly back to normal, and yet high unemployment persists. Mr Hall says this could be due to the unusual composition of employment (with many long-term unemployed, for instance), but that feels a bit like adding epicycles to the model. More importantly, the zero lower bound is only a binding constraint because inflation is assumed to be limited to low and stable rates.

And so I think a real problem with the paper is the failure to lay out a rigorous account of the central bank's reaction function. Mr Hall assumes that central banks are effectively doing all they can:

It's fairly obvious that monetary policy does not have instruments to restore ZLB economies to their normal conditions, else much more progress back to normal would have occurred.

Yet that raises a critical question: how can we know this? How can we know that even more intervention would not have generated more progress back to normal? Similarly, how can we know that the path of the recovery doesn't more or less reflect the Fed's preferences? While we should certainly explore many different stories about the recovery, there is a parsimonious explanation for the economy's behaviour sitting right in front of us: that inflation has been relatively stable because the Fed has targeted stable inflation, and the Fed's choice not to raise inflation higher—and thereby reduce the real interest rate further—accounts for continued high unemployment. That should be the null hypothesis, and I'm not sure on what grounds Mr Hall rejects it. We should assume that a central bank with the ability to print money and buy extraordinary quantities of assets and foreign exchange can raise inflation if it wants to.

There are still some puzzles in this framework, such as why the slack has not led to more disinflationary pressure, and therefore to more of a monetary response to keep inflation near (ish) to 2%. But as Mr Krugman notes wage and price rigidities are probably playing a role. Some recent research explains how and when rigidities may bind and lead to "pent-up disinflation".

As Mr Hall acknowledges, the prevailing view of what to do in the face of a liquidity trap—commit to making up lost nominal ground or, as some would have it, "promise to be irresponsible" and allow inflation above target for a time even after unemployment returns to "normal" levels—seems pretty compelling. Perhaps if a central bank actually gave it a try we'd have a better sense of just how many of the questions addressed by Mr Hall actually need to be answered.