raghu
Sat, 28 Aug 2010 08:13:36 -0700
Just a follow up on this. I have been a bit obsessed with trying to get into the head of Kacherlakota and find out just what his reasoning on this may be. There has been some exegesis on this passage in the econ blogs in the last couple of days. The best explanation I have seen comes from Karl Smith (quoted below). If this is really the level at which the Minn Fed President thinks, we should all very, very afraid.. http://modeledbehavior.com/2010/08/25/bang-bang-kocherlokta-on-deflation/ --------------------------------------snip Kocherlakota suggests that the superneutrality of money implies that a low Fed Funds rate will lead to permanent deflation. This is true in a frictionless world with perfect information. A permanently low funds rate combined with a constant real rate of return would imply deflation. It is also the case that the Fed choosing a permanently low funds rate would cause the deflation to come about. The question is: how do we get to deflation from here. You actually wind up with what’s known as a bang-bang solution. That’s where the economy instantly jumps to a new equilibrium path. That is, everything we think we know suddenly changes and then works itself out from there. There is evidence of quasi-bang-bangs in real life. When the stock market suddenly crashes on a piece of bad news but the slowly creeps up from there, that’s essentially bang-bang. With money and deflation what you’d have to be suggesting is that as soon as people realized that the Fed was committed to this path, prices on everything, not just stocks and bonds but everything, instantly jumped sky high. So, high in fact that from there on out we would be set up for permanent deflation. In the real world such an instant transition is not possible because there are frictions and uncertainty. What is possible is hyperinflation. Hyperinflation that would then leave the price level so high that deflation from then on out was the norm. On Fri, Aug 27, 2010 at 5:37 PM, raghu <mragh...@gmail.com> wrote: > On Fri, Aug 27, 2010 at 3:12 PM, Jim Devine <jdevin...@gmail.com> wrote: >>> Long-run monetary neutrality is an uncontroversial, simple, but >>> nonetheless profound proposition. In particular, it implies that if >>> the FOMC maintains the fed funds rate at its current level of 0-25 >>> basis points for too long, both anticipated and actual inflation have >>> to become negative. Why? It’s simple arithmetic. Let’s say that the >>> real rate of return on safe investments is 1 percent and we need to >>> add an amount of anticipated inflation that will result in a fed funds >>> rate of 0.25 percent. The only way to get that is to add a negative >>> number—in this case, –0.75 percent. >> >> The problem with this fellow's analysis is that the current situation >> belies the NC concept of the long run. That idea assumes that the >> economy will attain something like full employment in the foreseeable >> future.[...] When and if we attain that situation, we won't see a fed funds >> rate equal >> to about 0.25%. It would be more like 4%, in which case a 1% safe rate >> would correspond to about 3% expected inflation (for loans of similar >> maturity, i.e., overnight). _______________________________________________ pen-l mailing list pen-l@lists.csuchico.edu https://lists.csuchico.edu/mailman/listinfo/pen-l