A neo-Fisherian experiment that hedges its New Keynesian bets

The experience of a country like Japan, where interest rates have been at their floor for 2 decades now, and inflation is still undershooting the BoJ target of 2 per cent, is enough to test the faith of a New Keynesian and make one wonder whether the neo-Fisherians have a point.  They maintain that inflation undershoots the target because of very low interest rates, not despite them.  New Keynesians deduce from their version of the model that a temporary interest rate cut raises inflation and vice-versa.  They extended that logic to deduce that an extremely protracted recession and undershoot of the inflation target should be responded to by keeping interest rates at their floor indefinitely.  Neo Fisherians think that indefinitely low interest rates is what keeps inflation low, not what will cure it.

The ‘Fisherian’ bit of the name comes from the Fisher relation, which asserts that in the very long run central bank rates and inflation move one for one in step with each other.  Neo-Fisherians are those who argue that inflation would rise in step with central bank rates from their current starting points not only in the long run, but also in the short run too.

What about experimenting with temporarily higher rates to see if the Neo-Fisherians have a point?  This could be ruled out using logic along the lines of Pascal’s wager.  (Pascal decided to feign belief in God on the grounds that if there was no God, he had simply wasted some time.  But if he stuck with his atheism proper and that was wrong, he would be damned for an eternity.)

The cost of trying out a Neo-Fisherian rise in rates, if vanilla New Keynesianism turns out to be true is, in the worst case, another recession and losing control of inflation on the downside.  By contrast, if the past is  reliable guide, then the cost of continuing vanilla New Keynesian policy when the world is actually Neo Fisherian is another period of inflation somewhat below target and reasonable growth.

However, a modification to the experiment makes it more attractive for a policymaker playing according to Pascal’s wager:

Suppose instead we pre-announce two things:  1) a temporary increase in interest rates, relative to some previously expected and intended path;  2) a temporary fiscal stimulus, calibrated to offset the interest rate rise under the assumption that the world was vanilla New Keynesian.

If the world turns out to be New Keynesian after all, there is no harm done.  The monetary tightening and fiscal loosening offset.  If the world turns out to be Neo-Fisherian, we get a temporary boost to inflation.  Which can be locked in after the experiment with a more determined effort, and without the need for a further fiscal stimulus.

There are communication and practical issues that would have to be thought through.   But if the concepts are right here those issues might, for a central bank with few other options, be worth trying to surmount.

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Phillips Curve bashing and immaculate inflation

A few points prompted by the recent exchange between David Andolfatto and Paul Krugman, and the recurrent phenomenon of comment pieces on the demise of the Philips Curve.  These pieces are hot lately because of the surprising coincidence of falls in unemployment with a failure of inflation to pick up materially, particularly in the UK and the US.

First, fluctuations in the correlation between unemployment and inflation – which have been a thing ever since I can remember paying attention [see, for example, this paper by Luca Benati] – don’t tell us much on their own about the existence or not of the aggregate supply relations that comprise the Philips Curve in modern macro models.  A shifting mixture of shocks to demand and supply can change this correlation straightforwardly in model world. Shifts in the data are therefore not themselves sufficient to refute the model and its Philips Curve.

Second – a point Nick Rowe reminded me to make – is that the existence of the Phillips Curve nonetheless does not entitle us to say that falls in unemployment ’cause’ a rise in inflation.  The proximate cause is the underlying demand shock, in this case.

Third, if you want to attack the Philips Curve, it seems to me you have to contend that neither prices, nominal wages nor information sets are sticky.  With any one of those present in a model, a monetary shock that constituted a loosening would cause a positive output gap.

The empirical macro data concludes, from what I recall, that nominal – eg monetary policy – shocks do have real effects.  So this is counterfactual for those who believe in flexible prices/information.  One can certainly debate how well such shocks are constructed and identified.  But the result is remarkably robust.  And then there is the data from surveys and micro price data, which it would take a fairly extreme position to reconcile with a flexible price spot market.

Fourth. The other thing that can generate shifts in the Philips Correlation is a shift in model parameters, including those that define the natural rates. This may be seen as symptomatic of the fact that the model is incomplete and wrong in some respect. But, to re-emphasise, if you subscribe either to sticky prices, wages or information sets, or all three, then whatever model you later find that explains this initial apparent parameter shift is going to have embedded within it a set of aggregate supply relations that we would recognise as a modern Philips Curve.

Fifth, one occasionally witnesses interlocutors sceptical of the PC conceding these points but nonetheless claiming that the PC or the natural rate of unemployment is ‘not a useful’ concept for policy, given uncertainties about its building blocks.  This argument makes little sense.  Policymakers have to take models and the uncertainty about their constituents as they find them and set policy accordingly.  If they see that the natural rate of unemployment is uncertain, then they consult the literature on monetary policy and natural rate uncertainty and act accordingly.  Optimal policy in the presence of such uncertainty is different from that in its absence.  But natural rate uncertainty doesn’t imply that one should simply drop the idea and look for a new policy ingredient.


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Konig-Krugman fiat fundamentalism and Bitcoin

JP Konig writes as engagingly as ever about whether Bitcoin and central bank fiat currency differ in possessing inherent value, and what underpins their value.  He takes Paul Krugman’s side.

Krugman points out, correctly, that governments accept, in fact demand payment of taxes using the currency of its own central bank.  The same of course does not apply to Bitcoin or any of the other crypto-currencies.  At least not yet.  This, he says, is what underpins the value of fiat currency.

In the same vein one might similarly add that the government enacts a law of legal tender.  This law provides that a debt settled in fiat currency is settled.  If you contract in advance to sell something for £10, you cannot later complain that the debt is not settled if you are given £10, a complaint that you may take to the civil courts to obtain redress if you were to object to receiving instead £10 worth of bananas.  As well as demanding £ itself, the government seems to demand we also accept £.

However, I want to take a different position.

I would like to assert that the government’s demand that debts to it [ie taxes owed] be settled in fiat currency are an equilibrium response to the prevailing fact that that fiat currency has value, in the sense that it can be reliably be exchanged for things that the government wants.  Or rather, be exchanged for things that the government’s creditors [like civil servants owed salaries] might want [namely goods and services] after the government has tried to settle its debts by palming off the fiat currency it took in in lieu of taxes.  It is not an unconditional promise or demand that would prevail in all possible circumstances.  In so far as it is presented as one, it has to be considered a bluff.  Observationally, a deft policy to help select a monetary equilibrium and a rather prosaic one to help raise a convenient source of finance for government business look the same.

The authorities don’t explain the conditionality of tax demands openly.  Tax demands are not accompanied with riders that say ‘if the monetary framework and therefore the value of money were to implode between now and when your tax payments fall due, we may ask for payment in something else’.  This is because – I assert – if those riders were inserted, they fear it might unsettle confidence in money and make the highly unlikely implosion of the monetary equilibrium somewhat more likely.

Why is the tax demand/promise not unconditional?

If society turned against money for some reason, right or wrong, the government’s own best interests, whether those coincide with its citizens or not, would ultimately be served by taking what was useful to it in executing its business;  it will have civil servants, teachers, doctors and nurses and soldiers to pay.  If they want – or rather need – something other than fiat currency, in extremis, to manage their own affairs, they will get it, because if they do not the government will not be able to fulfil its basic obligations to maintain public services and law and order.  The analyst piping up about defending the old monetary order will be drowned out by the overwhelming need to pay and feed people.

Indeed, it’s possible to conceive that society turns away from fiat money and towards one of the crypto currencies.  Not very likely, given the protocols used to manage their supply, which induce high price volatility, and many other reasons right now.  But for the sake of our argument here, if society did turn to crypto currencies to do its record keeping, the government would, eventually, have to give in and accept crypto in lieu of taxes.

Thus, government behaviour here is codetermined with, and not the ultimate determinant of the value of the fiat money it issues.  Money is not treated as an asset solely because the government treats it as a liability.  It is at the same time true that governments treat money as a liability because others treat it as an asset.  Both behaviours emerge from successful management of the fiat supply protocol and the magic of equilibrium selection!

This same debate crops up in discussions of the merits and dangers of helicopter money.

I wrote about this before, but to recap:  helicopter money proponents have railed against their adversaries for asserting that since money is a ‘liability’, dropping loads of it on the private sector cannot have a wealth effect, and stores up trouble for the authorities.  [Echoing those that argue that helicopter drops of bonds would not be net wealth for those who catch them]. The assertion that money is a liability is sometimes linked to the fact that currently it is accepted as such in lieu of taxes [money deducts from its assets, tax claims, and hence is treated as a liability].

Repeating the argument I made above, I would argue that money may be treated as a liability currently, but only because the authorities know that its creditors will treat it as an asset subsequently.  And this is a behaviour that emerges in response to the current monetary framework and how it is operated.  Not one that would be expected to obtain regardless, unconditionally.  Money may seem like a liability now, but perhaps not in the future, and relevantly perhaps not after several large and unusual doses of helicopter money.



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Bloomberg View column on BoE fan charts

Latest column with Richard Barwell, once again arguing that the BoE should publish interest rate and QE fan charts based on its estimate of what it would do given how it sees the world developing.

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1p/2p/…/£50 = a/b/…/c as a nominal anchor that does not require measuring the price level

Here is a new post on FT’s Alphaville blog on this topic. It is somewhat crackpot. If anyone knows whether this has already been formalised please let me know.  Asking for a friend.

One thing that did not make the editor’s cut there is this….

Recapping, the basic idea is to get the central bank to target the voluntarily held denomination ratio, which I think is equivalent to it targeting the price level.

Why do this?  I don’t know.  Maybe the whole monetary framework is just not believable for some reason and we are hunting around for a reason to keep the 1p.

Bonkers though this idea is, it has one thing commending it, that denomination ratio targeting doesn’t require measuring the price level.  All it requires is being able to measure the exact number of each denominations that have been issued, which is standard business management for a Mint or Note Issue department.  This is intriguing because in modern economies we worry about our ability to measure prices when the product mix or quality of goods is changing a lot.  The advent of smartphones, apps and all the rest of it has posed just that question about our statistics. [Is the productivity puzzle a fact or an artefact?]

Having the BoE target both the denomination mix and conduct the note issue might not look good, however, as it would have an incentive to force the note mix on the private sector if outcomes were not looking good.

So that suggests delegating the note issue to a fully independent Mint [ie a Mint that would have to be as separate from the Treasury and the BoE as the current BoE is from the Treasury].  This opens up a Pandora’s Box of consequential institutional technicalities to make sure that only the BoE can do monetary policy and LOLR.  Probably something for another post.

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Here is my New Statesman post on the idea of abolishing the 1p.

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Alphaville post on the Venezuelan Petro

ICYMI:  guest post on the Petro and the Assignat.

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