From the Great Depression to the contemporary days: is the reallocation of resources a solution?

Former Governor of the Bank of England, Mervyn King is suggesting that Economics Needs a Post-Crash Revolution in a seeming admission that current frameworks don’t work in a world of radical uncertainty and necessary reallocation.

Is the former BOE governor and academic icon correct, or is this an unfair critique of the mainstream?  As a summary, I have two issues with his argument:

  1. Reallocation does not have anything to do with “average demand”, which is predominantly a monetary policy issue,
  2. If excessive reallocation is necessary and requires government assistance, where are the “high return” industries that need reallocation to them?

Let me explain.

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A note on Qualitative easing

While the concept of quantitative easing has received a lot of attention amongst economists, qualitative easing was not as widely discussed. Qualitative easing is a monetary easing program that was used by Japan in 2013 and represents some elements of the QE programmes in the US. 

The outline of how it works is well described here, and so I want to focus a little bit more on why.

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Do we make choices based on income or prices?

Last time we noted the following regarding thinking about NGDP level targeting:

To understand what is going on we need to ask what expectations are being “set”, what is the “target” and how do these reflect what a central bank can “do”?

Expectations: We know they can be adaptive (backward looking) or rational (forward looking), but what do they refer to? Are people making choices based on expected prices, or are they making choices based on expected incomes? Do they view shocks as permanent or temporary?

Target: Is the goal to anchor the price level, or to anchor the level of expected nominal income growth? Is it to limit variability in prices and output?

What they do: If a central bank wants to increase prices can it, if it wants to increase nominal incomes can it?  If they can do both, how does this influence their ability to “close output gaps”?

Here I want to discuss a little more about expectations.

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How does nominal income targeting work?

Thanks to Dr. Kirdan Lees for prompting me to write today’s post. Today’s topic of discussion is nominal income targeting.

What is nominal income targeting? 

Nominal income targeting is usually viewed as an alternative monetary strategy to inflation targeting, and has never explicitly been applied in practice by any central bank. However, there is an overwhelming amount of literature discussing this monetary policy tool and how it compares to the flexible (inflation) targeting.

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Should a central bank target wage inflation instead of price stability?

Olivier Blanchard’s recent speech at the Brookings Institution event “What’s (not) up with inflation?” encouraged me to write this post.

Blanchard is still my second favourite economist (after Matt Nolan of course 🙂 ). But despite that I felt that some of the important elements of the discussion was missing, and I didn’t fully agree with some of Blanchard’s arguments on GDP inflation being used in the same way as the CPI inflation, which needs a separate post perhaps.

Today I want to discuss wage inflation, price inflation, and central bank targets.

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When to run the economy hot?

Former Fed Chair Janet Yellen has recently suggested it is a good time to run the US economy hot (in the short-run) underpinned by the argument that the further fall in unemployment rate didn’t drag the inflation up.

The justification behind this is that the Phillips curve appears to have become quite flat.  As a result, stronger demand need not drive up inflation by much – suggesting we have a situation where, even with relatively low unemployment, inflation expectations are strongly anchored. 

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