Saturday, January 8, 2011

Lag This

from Billy Blog post of 31 December 2010:

If you go back in history (last 30 years) and examine monetary policy-led dis-inflation exercises the stark reality is that they always open up the output gap (that is, slow the economy). The question is how much. The problem with monetary policy is that the informational feedback is too lagged to be a good guide as to when enough is enough. By the time you realise the rate hikes are impacting negatively on spending it is too late and the problem has been overcooked.

Billy's question -- How much?? -- is the wrong question. It suggests that if those "monetary policy-led dis-inflation exercises" were nuanced just right, they would not have slowed the economy. Nonsense.

Billy knows -- heck, even the central bankers know -- that the purpose of the exercise is to slow the economy. The goal is to slow the economy so that aggregate demand is reduced, so that inflation is reduced. There is a direct link -- or, rather, there is believed to be a direct link between demand and inflation.

That link exists, of course, but it exists between "demand" and "demand-pull" inflation. There is no link between demand and "cost-push" inflation, which is the kind of inflation we've had since stagflation first arose in the 1970s.

Billy says there's nothing really wrong with monetary policy, except it's too slow. Billy says fiscal policy is quicker. That's funny, because economists used to say fiscal policy was too slow and monetary policy was quicker.

Billy is wrong when he says the only problem with monetary policy is that it's too slow. The real problem with monetary policy is that doesn't work the way central bankers think it works.

Central bankers ignore monetary imbalance. They do not think about the relation between money-in-circulation and credit-in-use. Like most people they seem to equate money with credit. That's a mistake.

When you put finance people in charge of policy, they cannot see debt as a problem.

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