Murky Macroeconomics: ...I realized something not too flattering about myself: I’m feeling nostalgic for 2011 or so.
Why? It was, of course, a terrible time for much of the world, and especially for anyone without a job. But for ... an economist ... it was a time of wonderful intellectual clarity. Liquidity-trap macroeconomics ... had become the story of the day. And the basic message of the models — that everything changes when you hit the zero lower bound — was being overwhelmingly confirmed by experience.
The thing is, it was all beautifully hard-edged: a crisp boundary at zero, a sharp change in the impact of monetary and fiscal policy when you hit that boundary. And the predictions we made came out consistently right.
But now things have gotten a bit, well, murky. The zero lower bound is not, it turns out, quite as hard a boundary as we thought. ...I’d be surprised if any central bank is willing to go much if at all below minus one percent — but it turns out to be a sort of a fuzzy no-man’s-land rather than a line that cannot be crossed.
More important, probably, is the fact that two of the major advanced economies — the US and, believe it or not, Japan — are arguably quite close to full employment. We don’t know how close... But you can no longer argue that supply limits are no longer relevant.
Correspondingly, you can also no longer argue with confidence that there can be no crowding out, because the Fed won’t raise rates. You can argue that it shouldn’t — and I would — but we are maybe, possibly, on our way out of the liquidity trap.
So we’re not in the simple, depressed-economy world of 2011 anymore. But here’s the thing: we’re not in what we used to call a normal macroeconomic situation either. Maybe we’re close to full employment, but maybe not, and that’s with near-zero interest rates; also, it’s all too easy to imagine adverse shocks in the near future, and not at all clear how the Fed could or would respond. We are, if you like, half-out of the liquidity trap, with one foot on dry land — but the other foot is still hanging over the edge, and it wouldn’t take much to topple us right back in.
What I would argue is that in this murky, fragile situation we should be conducting policy largely as if we were still in the trap — because we badly need to get both feet firmly on dry land with some distance between us and the quicksand. ... But it’s not the crystalline case we used to be able to make.
Still, we need to deal with this murky situation right, which means embracing the uncertainty as part of the argument. Make murkiness great again!