Two undervalued points in thinking about monetary stimulus

Tyler Cowen does his normal thing of making a lot of very good points other people aren’t.  For me these two are key:

  1. The rate of unemployment in Japan, last I checked, was 4.1%.  Yes, they calculate it differently than we do, and yes in their heyday they had an even lower rate of unemployment.  But still, ask yourself: just how labor market slack is there going to be?
  2. An alternative is that money will boost real economic activity through a Lucas supply curve combined with a fair degree of money illusion, which is what you would expect from a longstanding deflationary environment.  Businesses will confuse nominal changes with real changes, raise output, and eventually figure out the confusion and restrict output again.  The economy does get to keep a one-time gain (probably there are positive social externalities to higher output in this setting), but it doesn’t drive an enduring recovery.

The unemployment rate issue is one I have had in the back of my mind.  My presumption has been that Japan has, in recent quarters, been facing a sharp drop in demand – and as a result they are responding to a recent shock.  The stimulus isn’t about their long-run failure to me, it is a monetary policy response to a recent shock.  I am also happy that they appear to be setting up a framework that will deal with similar shocks in the future.

There seems to be this accidental view appearing when may of us, including myself, write about monetary policy – a view where we start to undermine the medium-long term neutrality of money.

Either we need to explicitly state how there is a “multiple equilibrium argument for how the neutrality of money breaks down in this circumstance” (this would certainly take us down the rabbit hole …), or we need to assume that there has been a number of shocks that have built up upon each other.

If we assume the first we are on pretty intense and shaky ground, and need to make sure our arguments are crisp and transparent.  If we assume the second (which is the camp I am closer to when looking at NZ) then we can’t say that the central bank ex-ante failed UNLESS they could have foreseen the shocks.  If the shocks are things such as policy incompetence in Europe, and sudden large shifts in commodity prices and the exchange rate, then they are indeed unforeseeable!

9 replies
    • Matt Nolan
      Matt Nolan says:

      As a useful thought experiment, and a way of reducing some other explanations to typical theory!

      And for countries that have experienced large shocks, some type of multiple eqm argument could well be true – it just needs to be fully articulated is all 😉

  1. Luc Hansen
    Luc Hansen says:


    From what I have read about the motivations for the BOJ’s actions, its goal is increased inflation.

    Therefore, surely Japan’s low unemployment rate is a positive for the goal, not a negative.

    This is because a relatively large pool of unemployment means monetary or fiscal expansion would have some work to do before shifting inflation expectations to the point where people prefer to spend rather than save or pay down debt.

    And Japan’s demographics creates even more headwind, so the people there need a lot of persuasion that the government is going to fuel (modest) inflation, come hell or high water!

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