Wednesday, 1 September 2010

Kocherlakota has a mentor

Paul Krugman (quoting Jan Hatzius) uncovers another scary article from another Fed president:
Third, the statement seems to be at odds with a recent article by President Bullard of St. Louis suggesting that a continuation of the Fed’s current stance on short-term interest rates could result in deflation (see “Seven Faces of ‘The Peril’”, July 28, 2010). The first sentence of the abstract reads: “In this paper I discuss the possibility that the U.S. economy may become enmeshed in a Japanese-style, deflationary outcome within the next several years.”
The original report from Bullard can be found here. Guess who is thanked in the footer of page 1? Narayana Kocherlakota (as well as David Andolfatto, regular blog commentator on Worthwhile Canadian Initiative and TheMoneyIllusion).

So what's going on? The paper is making the same argument for which Kocherlakota has been pilloried over the last two weeks. But the paradoxes in that paper are layered with yet more contradictions:
  1. Hatzius quotes the FOMC minutes which say that there is little risk of deflation - and yet Bullard, who is on the committee, is arguing that the Fed's low interest rate policy may itself cause deflation.
  2. Hatzius, like Krugman, is disagreeing with the FOMC's view and agreeing with Bullard that there is a risk of deflation but their prescription is the opposite of Bullard's - keep interest rates low.
  3. Bullard comes to the same bizarre conclusion as Kocherlakota - low interest rates cause deflation - but then deduces from this a sensible corollary - we should continue quantitative easing!
  4. Bullard came up with all this before Kocherlakota - in fact for all we know, Kocherlakota got his speech from reading Bullard - but Kocherlakota got all the blame.
  5. While everyone thinks Kocherlakota is very hawkish, Bullard is described as a dove.
I won't go over again all the reasons that Bullard and Kocherlakota are wrong - Andy Harless, Nick Rowe, Scott Sumner and Karl Smith have done that very well.

But the chain of logic here has so many inversions that I think I'm in a Borges novel.

p.s. this paper was already spotted by Money Demand last week.

1 comment:

Nick Rowe said...

James Bullard is much more ambiguous.

At one level, he is certainly very aware of the Wicksell problem, and of analysis of that problem that are more sophisticated than my own intuitive understanding of that problem. He knows that the bad steady state is locally unstable.

But he also worries (this is how I interpret him) that promising a long period of 0% might make that bad unstable steady state more prominent in people's expectations, making it more likely we go there.

He seems to flip between: saying that doing 0% for an extended period, *but not doing anything else to get us out of the trap*, would be dangerous (which is correct as far as I can see); saying that doing 0% for an extended period (rather than a short period) could make things worse (which looks wrong to me).

Dunno.