Friday, August 10, 2012

Doubting Lars

In a look at Cochrane’s inconsistencies, Lars Christensen writes

Cochrane seems to be very upset about the calls for easier monetary policy in the euro zone... Here is Cochrane:

“As you might have guessed, I think it’s a terrible idea...“

Hence, Cochrane thinks easier monetary policy is very evil. However, in the in the comment section Cochrane states the following:

“I like a price level target. I view money as a set of units for value, and I don’t think the government artfully devaluing the meter and kilo to give shopkeepers a boost is a good idea, any more than fooling with inflation to do so, even if it does “work,” at least once.”

Anyway, note that Cochrane says he likes a price level targeting regime. Fine with me. Then why not endorse Price Level Targeting for the euro zone professor Cochrane?

The graph below shows the euro zone GDP deflator and a 2% trend path for prices. The 2% path is of course what the ECB would be targeting if it implemented a Price Level Target as supported by Cochrane. Now have a look at the graph again and tell me what the ECB should do now if it was a Price Level Targeter?

The graph is very clear: Monetary policy is far too tight in the euro zone and as a result the actual price level is far below the pre-crisis 2% path level.

If Professor Cochrane was consistent in his views then he would obviously conclude that the ECB’s failed monetary policies are keeping the euro zone price level depressed, but I am afraid he did not even care to study the numbers.

Cochrane should obviously be calling for massive monetary easing in the euro zone. Milton Friedman would do so.

I can only again say how sad it is that the University of Chicago professors continue to disregard the economics of Milton Friedman.

The excerpt is a bit long, but I wanted to provide context for the bit of it that interests me: Lars Christensen misinterprets Cochrane, and then says Cochrane is not "consistent".

Cochrane compares the price level to the meter and the kilo, and says it is wrong to devalue any of them. Cochrane does not say 2% inflation is okay. Cochrane wants prices as stable as the meter and the kilo.

Myself, I'm impressed by Cochrane's clarity. But Christensen doesn't see it. Strikes me as convenient obtuseness on Christensen's part.

Christensen wants easier money, if I have it right. There is a gap between the Euro zone deflator and the 2% trend line, and Christensen wants to fill that gap with money.

That's a simplistic solution.

Cochrane doesn't want the deflator to hug the 2% line. He wants it horizontal.

I respect that.

Cochrane has clear preferences. In Myths and Facts About the Gold Standard, he said:

The Fed currently interprets "price stability" to mean 2% inflation forever. A CPI standard could enforce 2% inflation. But why not establish a price-level target instead? The CPI could be the same 30 years from now as it is today, and long-term contracts could carry no inflation risk.

"The CPI could be the same 30 years from now as it is today," Cochrane says. You know what that is? It's a horizontal deflator. It's not a 2% line. Christensen misinterprets.

Yes: If we don't fill the graph with money like Christensen wants -- if we stabilize prices at zero inflation -- then we have to do something else. We have to do something other than printing more money, to fix the economy.

That's what this blog is about.

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