Tuesday, October 02, 2012

Murphy Puzzles Over Sumner

But without need! Bob writes:

"But what of the second part of Sumner’s quote, where he says: 'The huge decline in house prices between 2006 would not be expected to cause a major recession, and indeed would not have caused one had NGDP not declined.'"

"I still say there’s something really screwy about this approach. Absent huge swings in the price level, a recession is the same thing as a drop in NGDP."

I believe Sumner thinks like this:

In Year 1 (Y1) we have an economy going along nicely, RGDP growth (R) = 3% and NGDP growth  (N) = 5%.

In Y2 there is, say, a supply side shock, dragging R down to -1%. But the Fed does its job and, with 6% inflation, keeps N at 5%.

Because of the Fed's action in Y2, in Y3, the economy rebounds, with R = 4% and N = 5%. If the Fed had allowed N to drop to 1% (if inflation had stayed the same) or even lower (if the shock had increased liquidity preference) then the economy might have been mired down for several years.

As I understand him, Sumner sees the Fed's job as inflating until the risk of prolonged recession goes away.


  1. Not quite: the job of the Fed is to keep nominal spending up until ...

    That might involve some increase in inflation, but the job of the Fed is not to inflate as such.

    1. If RGDP drops to 1%, then to keep NGDP at 5%, we need 4% inflation. If your job is X, and right now the way to do X is to do Y, then right now your job is to do Y!

      Your quibble is as though my boss tells me, "Gene, your job is to to talk to these students if they are confused" and I reply "Oh no, you said my job is to teach these students the material!"

    2. My quibble--it is indeed a quibble--is mainly about the framing. But the framing matters, not merely because some folk what to obsess about inflation but also because a central bank having credibility about inflation but not spending turns out to be very bad thing.


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