Friday, February 7, 2014

Kimball on Ending Recession and Inflation

Kimball has an interview on Wonkblog about electronic money and interest rates.    I am not sure where the "ending recessions forever" actually came from, but that seems a bit oversold.   I don't think all recessions are associated with the zero nominal bound.   Surely, there are some supply side recessions.    Allowing short and safe interest rates to fall below zero would at best make potentially deep recessions that drive the nominal interest rate to zero a bit milder.

However, since central banks can expand the quantity of money enough to avoid a deep recession, negative interest rates really allow the central banks to continue with "business as usual."   A central bank can focus on a short and safe interest rate.  Further, the needed increase in the quantity of money would be smaller.  A negative interest rate on reserves will reduce the demand for reserves.   It should be possible to have a "bills only" monetary policy.

Kimball also says that electronic money will end inflation.   Here he depends heavily on the notion that the reason for having trend inflation is to keep nominal interest rates higher on average and reducing the chance of hitting the zero nominal bound.    In other words, again, the "problem" with zero trend inflation is that it interferes with central banks' "business as usual."  That is, focusing on periodic changes in a short and safe interest rate. 

I favor a stable price level on average, but I think that the price level should rise with adverse supply shocks and fall with favorable supply shocks.   Trying to keep the price level fixed would result in deeper recessions with adverse supply shocks and tend to cause booms with favorable supply shocks, even with electronic money.   Negative interest rates to prevent unusually rapid growth in productivity from causing deflation seems like a very bad idea.   

Kimball is very skeptical of suspending currency payments as a solution to the zero nominal bound.   Perhaps the reason I find it less troubling is that I know that free banks in the 18th century had an option clause to allow the suspension of currency payments.   Governments interfered with freedom of contract, and the option clause disappeared.   But in practice, suspensions occurred regularly in the 19th century.   They were just illegal.  

On the other hand, I favor the private issue of hand-to-hand currency.   As long as private currency isn't government insured, the interest rate on central bank reserves and Treasury-bills might be quite negative before anyone decides that bank-issued currency is a better store of wealth.  



3 comments:

  1. It seems utopian to believe that optimal monetary policy could eliminate _demand_ side recessions. (I don't know if anyone believes it could, but sometimes rhetoric suggests it). Optimal just means we can't do any better.

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  2. Thanks, Bill! I need to write a full post to reply to this.
    --Miles

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  3. I posted a reply on supplysideliberal.com :
    http://blog.supplysideliberal.com/post/76196184332/reply-to-bill-woolsey-on-the-possibility-of-ending

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