Monday, April 25, 2011

Don Boudreaux makes a good point (about why NGDP should be the focus of macro)

On this podcast Don Boudreaux makes the best argument I've heard in defense of the Fed's monetary policy since 2008 (ironic, since he is anything but a friend of the Fed), at least if you think like the typical economist.

He asks what the difference is between changing the rate of inflation from say, 14% to 4% is from changing it from 3% to 0%.

It could be argued that at 4% inflation real wages were gradually pushed down whereas at 0% they aren't, but all things considered his point stands up very well so long as you are focusing on inflation.

If you look at NGDP however, this question can be easily answered. The Fed hasn't allowed NGDP to adequately grow. Compare the early 80's with the late 00's for example.

FRED Graph

FRED Graph

Looking at it like this it's pretty obvious that money was tighter in the Great Recession than in the early 80's.

Boudreaux also makes the Austrian argument that inflation should be defined as an increase in the money supply as opposed to an increase in the price level. I've never really understood this. I suppose Austrians are implicitly trying to apply the negative associations people have with the word "inflation" to increases in the money supply, which Austrians don't like. But people don't care about the money supply, they care about inflation.

And what about the early to mid 90's, when the money supply fell and velocity rose? Will Austrians really admit that they thought this period was deflationary? If not, they are admitting that velocity matters. If velocity matters than the recent, massive decline in velocity merits an equally large increase in the money supply. If only the money supply matters then I guess they don't really believe that the supposed stock market bubble was caused by monetary policy, not in the way they define it anyway.

(Edit: Another obvious problem with lowering the inflation target is that we were in the midst of a financial crisis!)

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