deflation and the zero interest bound federal reserve bank of minneapolis november 25, 2003 robert...
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Deflation and the Zero Interest Bound
Federal Reserve Bank of Minneapolis
November 25, 2003
Robert E. Lucas, Jr.
POLICY PROBLEM_________________________
Take as given (for sake of discussion)
(1) that task of monetary policy is “inflation
targeting”: maintenance of low, steady inflation
rate;
(2) that success requires continuous readjustment—
can’t set the controls and shut down the Fed.
TWO APPROACHES_________________________
(1) When inflation rate is above target, raise interest
rate; when inflation is below...
(2) When inflation rate is above target, reduce money
growth;….
Interest control vs. money supply control
PROBLEM OF DEFLATION___________________
(in public discussion) is a problem only for people
who think of policy exclusively in terms of
interest rate control.
“What if we find ourselves in a situation with
inflation below target (e.g. deflation) and near
zero interest rates?
There is nothing we can do. We’re stuck!”
SO WHAT ?______________________
Is deflation such a bad place to be stuck?
Fair question: Key issue in choice of target.
But once target is selected, must face question
of what to do when inflation is off target.
Important that policy rules generate action
that is (1) feasible and (2) moves inflation
closer to target, no matter what the state.
SO WHAT (CONTINUED) ? ___________
Won’t do to set 2% as target and then if -2% occurs say
“Oh, -2% is fine too. Let’s stay here instead.” No policy
at all.
If targeting is serious, and if interest rate setting is means
to attain it, then zero bound on interest is important.
Implies that central bank can be helpless to do job.
MONEY SUPPLY CONTROL_____________
With money supply control, dilemmas of deflation and near zero interest rates disappear.
Inflation below target? Raise money growth, inflation rises, interest rates follow.
How achieve this?
Open market operations at zero interest?
Ask someone from the Bank of Brazil.
EVIDENCE___________________________
But isn’t there solid evidence that interest rate control has been key to success in last 20 years of U.S. monetary policy?
Isn’t it well known that money supply growth is not reliably related to inflation?
Short answers are NO and NO. Look at
- cross-section of economies
- U.S. time series
INTERPRETATION______________________
Stable real rate plus inflation premium, a la
Irving Fisher?
Central Bank policy response to inflation?
My view? 100% Fisher
Believe figure contains no information on
central bank interest rate policy rules.
Interest and Inflation Rates, U.S. 1948-2000
-2
0
2
4
6
8
10
12
14
16
1948
1950
1952
1954
1956
1958
1960
1962
1964
1966
1968
1970
1972
1974
1976
1978
1980
1982
1984
1986
1988
1990
1992
1994
1996
1998
Per
cen
tag
e
3-Month Treasury Bill Rate CPI 1yr inflation rate + 2%
Source: Samuel Reynard Swiss National Bank
INTERPRETATION______________________
Same picture as cross section (though time
series harder to interpret)
My view? 98% Fisher
Believe figure contains no information on
central bank interest rate policy rules.
Taylor rule? Maybe. Or just misinterpretation of
behavior that Fisher has already explained.
….BUT WHAT IF…_____________________
…high interest rates did reflect, in part, Fed anti-
inflation policies? Did these policies in fact
influence consumer and business behavior?
More slippage here.
Various Monthly Yields: Low frequency only
CONCLUDE__________________________
Easy to see and understand effects of inflation on
short term interest rates, in U.S. and
elsewhere.
Hard to see (or imagine) any causal connection
from money market rates to spending flows
and inflation rates.
CAN MONEY CONTROL DO ANY BETTER?
Multiplicity of monetary aggregates…
Changes in financial technology…
Instability of velocity…
Many good excuses for not looking at money
data, but let’s do it anyway.
-6
-1
4
9
14
19
48
19
50
19
52
19
54
19
56
19
58
19
60
19
62
19
64
19
66
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68
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70
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72
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19
98Op
po
rtu
nit
y C
os
t (P
erc
en
t)
1.5
2
2.5
3
3.5
4
4.5
Ve
loc
ity
3-Month Treasury Bill Rate MA Opportunity Cost MA Velocity
Source: Samuel Reynard Swiss National Bank
UNSTABLE VELOCITY?_________________
From 1948 to 1976, velocity rose from 1.5 to 2.5
Suppose money growth had been set and locked in
1948 to attain a 2% inflation rate, assuming
constant velocity of 1.5.
Then actual inflation would have averaged 3.8%
Big mistake? I think so, but maybe no larger than the
mistake we actually made
…..and no need to be locked in!
WHAT IS AT STAKE?__________________
U.S. inflation record has been fine under interest rate policy. Why complain?
Aren’t “raise interest” and “reduce money growth” just two ways of saying the same thing?
No, they are not. Discussing monetary policy entirely in terms of interest rates leads us to describe situations of very low interest rates as situations where the central bank is helpless to raise inflation rate...
WHAT IS AT STAKE?__________________
…when in fact they are not helpless at all. Think of the U.S. Federal Reserve in the 1930s, and Japan in the 1990s.
What we say matters, not just what we do.
Bad economics leads to bad public debates, bad decisions, bad outcomes.
WE CAN DO BETTER__________________
ECB is discussing monetary aggregates and interest rates in a way that I like. See
Otmar Issing, et al., Monetary Policy in the Euro Area: Strategy and Decision Making at the ECB.
Good discussion of practical aspects of monetary policy…and no worries at all about deflation and the zero bound problem.
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