Home > Monetary Policy > Ride of the Volckery

Ride of the Volckery

I’ve returned from my hike across the beautiful Crawford Path. Sunday night, slightly sore and groggy, I read Paul Volcker’s warning in the New York Times to not pursue an inflationary monetary policy to solve our employment crisis.

My point is not that we are on the edge today of serious inflation, which is unlikely if the Fed remains vigilant. Rather, the danger is that if, in desperation, we turn to deliberately seeking inflation to solve real problems — our economic imbalances, sluggish productivity, and excessive leverage — we would soon find that a little inflation doesn’t work. Then the instinct will be to do a little more — a seemingly temporary and “reasonable” 4 percent becomes 5, and then 6 and so on.

What we know, or should know, from the past is that once inflation becomes anticipated and ingrained — as it eventually would — then the stimulating effects are lost.

Reading his op-ed left me slightly more sore and groggy. It is important to notice that Volcker implies that inflation would be stimulating in the short-run. I can’t for the life of me understand why he doesn’t consider 9% unemployment a “real problem,” but let’s move on. Volcker never explains why keeping inflation at 1 or 2 percent is optimal policy – he only worries that 3 or 4 percent will lead policymakers to try higher and higher rates. I guess once the Fed gets a little hit of that inflation soon they’ll be desperate for more only to keep up with those expectations. It’s only a matter of time, I suppose, that the abuser will be stagflating on the treasury room floor.

But is this gateway drug theory of inflation accurate?

I can’t be the only one that notices that inflation goes up and down. Every time we hit 3% inflation, we didn’t get hooked and ruin our longterm economy, right? Every person that takes a painkiller doesn’t become an oxycontin addict. Even though Volcker knows some junkie from the ’70s we shouldn’t conclude that sick people shouldn’t take medicine.

Here’s some other commentary on Volcker’s column:

Scott Sumner:

I have frequently discussed a bizarre schizophrenia in the way many pundits approach demand stimulus.   Monetary stimulus is “bad” because it leads to higher inflation.  Fiscal stimulus is good because it leads to more growth.


Volcker: “President Obama has now set out new proposals to support economic growth. I hope he will be able to work with a responsible Congress to find the common ground that is urgently needed to deal with the economic challenges before us, restoring a healthy economy ‘in a context of price stability.'”

I can’t make any sense out of that statement.  Isn’t Obama proposing fiscal stimulus?  And doesn’t fiscal stimulus work (if at all) by boosting AD and hence inflation?

Karl Smith:

My case is that 2% inflation is a fundamentally bad idea. I argue that 4% inflation is not merely “OK” it is preferable. It is preferable because in even in normal times it produces higher nominal interest rates. Higher nominal interest rates in turn give the Fed more leverage under traditional monetary policy.

When you consider the long run costs of inflation you have to consider that there will be unanticipated events. Some of those events will be deflationary. If you don’t have an adequate buffer the Federal Funds rate will bump up against zero.

Paul Krugman:

The big rise in prices during and after WWII arguably did a lot to eliminate the debt overhang, making it possible for the economy to enter a sustained, non-inflationary boom.

And this is the relevant history we should be looking at: this isn’t your father’s slump, it’s your grandfather’s slump. Volcker, I’m sorry to say, is worrying about refighting the 1970s when we’re actually refighting the 1930s. And fighting the wrong war is a good way to lose the one we’re in.

Matthew Yglesias:

I would turn the slippery slope point around. In the ’70s, inflation was clearly too high. So Volcker and his colleagues brought it down by producing a brutal recession. Then around 1990, Volcker’s successors nipped a new inflationary cycle in the bud with another recession. But this time, they brought inflation down to a lower level than it had been before the eighties. Why? What goal did this “opportunistic disinflation” serve? To me it looks precisely like mindless slope-slipping. Having been roundly congratulated for whipping inflation, policymakers decided to gain even more kudos by driving it even lower. But this hasn’t helped anyone, and, indeed, the best economic times of the past 30 years were the years in the late-1990s when Alan Greenspan let inflation hover around 3 percent before raising interest rates and inaugurating the ensuing 10 thin years.

Kevin Drum:

I think it’s worth keeping in mind that the inflation of the 70s wasn’t inevitable. It was the result of oil shocks and uniquely poor Fed policy. Arthur Burns could have kept the inflationary genie in the bottle if he’d had the spine to do it, but he didn’t. He was too much of a political hack. And a deliberately chosen one, too: Richard Nixon blamed his defeat in 1960 on tight money engineered by the Fed, so when he had an opportunity to appoint a Fed chairman of his own he made sure to appoint one who would provide him with the easy money policies that would keep the economy roaring.

  1. Bill
    September 20, 2011 at 8:25 pm

    Great analysis and synopsis of opinion Dan. Thanks for doing this-very helpful. I also liked your title!

    • September 22, 2011 at 7:55 pm

      Thanks Bill! I think the post flows even better if you listen to the music while reading it.

  2. Bill
    September 23, 2011 at 4:06 pm

    Definitely better with the music–but somehow I walk away feeling more like this song:

    • September 23, 2011 at 4:09 pm

      The clowns have definitely taken over.

  3. Bill
    September 23, 2011 at 5:50 pm

    Yes, the clowns. Your statement made me wonder if politics have always been this way, or that, perhaps, I have simply developed a more insightful eye for it. Still, I ask, how did we get to this point? When did reason sit on the bench while the empty rhetoric plays all nine innings? Where is the battle and why have the people of reason been so quiet-and I don’t mean just in the media, but in every day life. Is it anguish or is it fear?

    I did a quick search on “the responsibility of intellectuals”. Not sure what made me think of this term, but I did. And here is what I found: http://www.chomsky.info/articles/19670223.htm

    Here is a quick excerpt from the 1967 article in the New York Review of Books. Reading it made me consider the parallels between what was happening then and what is happening now. The exact events don’t matter so much as the response to them when discussing the role of those who can send the clowns back out.

    “WHEN WE CONSIDER the responsibility of intellectuals, our basic concern must be their role in the creation and analysis of ideology. And, in fact, Kristol’s contrast between the unreasonable ideological types and the responsible experts is formulated in terms that immediately bring to mind Daniel Bell’s interesting and influential “The End of Ideology,” an essay which is as important for what it leaves unsaid as for its actual content.[19] Bell presents and discusses the Marxist analysis of ideology as a mask for class interest, quoting Marx’s well-known description of the belief of the bourgeoisie “that the special conditions of its emancipation are the general conditions through which alone modern society can be saved and the class struggle avoided.” He then argues that the age of ideology is ended, supplanted, at least in the West, by a general agreement that each issue must be settled in its own terms, within the framework of a Welfare State in which, presumably, experts in the conduct of public affairs will have a prominent role. Bell is quite careful, however, to characterize the precise sense of “ideology” in which “ideologies are exhausted.” He is referring to ideology only as “the conversion of ideas into social levers,” to ideology as “a set of beliefs, infused with passion,…[which] …seeks to transform the whole of a way of life.” The crucial words are “transform” and “convert into social levers.” Intellectuals in the West, he argues, have lost interest in converting ideas into social levers for the radical transformation of society. Now that we have achieved the pluralistic society of the Welfare State, they see no further need for a radical transformation of society; we may tinker with our way of life here and there, but it would be wrong to try to modify it in any significant way. With this consensus of intellectuals, ideology is dead.”

    Tell me what your thoughts are on this Dan.

    • September 26, 2011 at 10:28 pm

      Well, it’s a lot to think about. But without meditating on it too deeply, I generally agree (probably to the disappointment of Chomsky and others) that in the West there is “no further need for a radical transformation of society.” The welfare state should be here to stay and we should just be making technocratic adjustments.

      The faster society can recognize this and drop ideologies and dogmas, the quicker we can make improvements in people’s lives. We don’t need to radically alter society, but a full commitment to reason and liberal technocracy can have immensely beneficial and pervasive results. Just because we know what the project is doesn’t mean it’s close to completion.

  4. Bill
    September 27, 2011 at 5:58 pm

    So, pragmatism over ideology. I want to agree, but to achieve positive results (improvements in people’s lives), through a commitment to reason, may require an ideological shift away from the current political ideology of conservatism. When speaking of “clowns”, we speak of those who act without reason-perhaps ideological in action rather than pragmatic. I feel its the role of the intellectual to point out the flaws of a prevailing ideology that runs counter to reason. In this way, the social levers we need to transform society could be raised. This transformation need not be radical, yet, I would suggest, is desperately needed.

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