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Wednesday, June 01, 2011

Classic Mistakes

Gavyn Davies discusses the Lucas lecture I noted the other day, and makes many of the same points -- the banking analysis is fairly standard, but the classical analysis of the crash leaves out any role for demand, and that is puzzling. (The lecture is a bit hidden and hard to find -- I stumbled on it by clicking on the graph in this post). As I said in my post, "It's not the 'lack of confidence' fairy that is holding things back, it's lack of demand."

Paul Krugman and Brad DeLong follow up on Lucas's refusal "to concede that, to even consider the possibility that we’re in a demand-shortfall slump of the kind Keynes diagnosed."

While were on this topic, Gauti Eggertsson of the NY Fed is worried about repeating the mistakes of the past -- mistakes we will make if we adopt the classical view of people like Lucas:

Commodity Prices and the Mistake of 1937: Would Modern Economists Make the Same Mistake?, by Gauti Eggertsson, FRBNY: In 1937, on the eve of a major policy mistake, U.S. economic conditions were surprisingly similar to those in the nation today. Consider, for example, the following summary of economic conditions: (1) Signs indicate that the recession is finally over. (2) Short-term interest rates have been close to zero for years but are now expected to rise. (3) Some are concerned about excessive inflation. (4) Inflation concerns are partly driven by a large expansion in the monetary base in recent years and by banks’ massive holding of excess reserves. (5) Furthermore, some are worried that the recent rally in commodity prices threatens to ignite an inflation spiral.

While this summary arguably describes current trends, it is taken from an account of conditions in 1937 that appears in “The Mistake of 1937: A General Equilibrium Analysis,” an article I coauthored with Benjamin Pugsley. What we call “the Mistake of 1937” was, in broad terms, a decision by the Fed and the administration to implement a series of contractionary policies that choked off the recovery of 1933-37 and brought on the recession of 1937-38, one of the worst on record. What is particularly noteworthy is that the inflation fears that triggered the Mistake of 1937 were largely driven by a rally in commodity prices. These circumstances invite direct comparison with our own time, when a substantial recent rise in commodity prices (which now seems to be abating somewhat) stoked inflation fears and led some commentators to call for an increase in the federal funds rate. ...[continue reading]...

His bottom line is a bit more optimistic than mine given that we have people like John Taylor calling for immediate rate hikes and contractionary fiscal policy:

The bottom line, then, is that it is unlikely that a modern economist transported back in time to 1937 would have preemptively tightened policy on the scale that policymakers did at the time. ...

    Posted by on Wednesday, June 1, 2011 at 10:17 AM in Budget Deficit, Economics, Fiscal Policy, Inflation, Monetary Policy | Permalink  Comments (8)


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