Jim Devine
Sat, 28 Aug 2010 08:49:07 -0700
raghu wrote: > I still don't see how to make sense of Kocherlakota's claim. Assume > that the Fed for whatever reason holds rates down at 25 bp even at > full employment. If "real returns" are larger than the interest rate, > isn't that going to lead to *inflation* rather than deflation. > > It is not that this guys assumptions are flawed. It is worse than > that. He is simply not making any sense.
That's right: if the fed funds rate = 0.25% at full employment, then there's an inconsistency (a contradiction, if you will). If the real safe rate (which is relevant at full employment) = 1%, then prices must indeed fall 0.75 at an annual rate, by definition.[*] But at full employment, this fed funds rate does not allow 0.75% deflation to exist (since it stimulates aggregate demand). The definition contradicts the way economies work. So something has to give. It can't be the definition, so that it's got to be the fed funds rate. I think we may be seeing the implosion of a brain trying to reconcile a Chicago-school view of the world (full employment always, except for temporary deviations) with a sustained aggregate demand failure in the real world. Karl Smith: >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 [of a persisttly low >fed funds rate], 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. This assumes the "new classical" crap applies, including persistent full employment (with minor wobbles) and so-called rational expectations. It shows a lack of concern for empirical reality, which has sunk the "new classical" boat. > 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.< No, if we keep the same currency, after hyperinflation (which is extremely unlikely when unemployment is so high), the only thing that can result is _slowing_ inflation (say, going from 100% per year to 50% per year), which is not necessarily negative inflation (deflation). This is a matter of definition, a definiton this person should know about. Actually, hyperinflation often leads to the abolition of an old currency and its replacement with a new one, a transition which can't be described as either inflation or deflation. -- Jim Devine / "Segui il tuo corso, e lascia dir le genti." (Go your own way and let people talk.) -- Karl, paraphrasing Dante. [*] I assume that actual inflation = expected inflation, so that there's no difference between the realized or _ex post_ real interest rate and the expected or _ex ante_ real interest rate. Dropping this assumption only complicates the story without changing its conclusion. _______________________________________________ pen-l mailing list pen-l@lists.csuchico.edu https://lists.csuchico.edu/mailman/listinfo/pen-l