Monday, July 20, 2009

Five things I read today -- 7/20

1. ChiTribune: It's easier to sell drugs than to sell water in Chicago.
2. ChiTribune: We should have a Walmart on the Southside. Speaking of Walmart...
3. Mankiw: Is "deficit neutrality" too easy a test? Yep.
4. Krugman: Ketchup Economists. Is he thinking Harrison and Kreps, or something else?
5. Tabarrok: Calling for an independent Federal reserve is disingenuous.


Technical note for economists: When I first read #5, I asked myself Doesn't he ignore the time inconsistency of the optimal policy? That is, it's optimal to commit credibly to low inflation, and one way to commit is to establish an independent Fed with the clearly-stated objective of keeping inflation low.

Then, I found this paper by Albeseni, Chari, and Christiano, which applies some serious rigor to that very question. The authors begin their conclusion by saying, "How severe is the time-inconsistency problem in monetary policy? Not severe at all, according to this study."

On the other hand, the authors point to another study of theirs that comes to the opposite conclusion: "Elsewhere, in Albanesi, Chari, and Christiano 2002, we have displayed a class of empirically plausible models in which lack of commitment may in fact lead to high and volatile inflation."

What should we take from this? The authors say, "Should we conclude from our results here that lack of commitment in monetary policy cannot account for the bad inflation outcomes that have occurred? We think such a conclusion is premature."

Therefore, we cannot reject the hypothesis that Congress will be tempted enough by the short-term benefits of inflation to revise away from the long-term optimal monetary policy. Placing the Fed under Congressional perview might still be a bad idea, but it might not.

The lack of a conclusion is frustrating if we want to know what to do. Instead of looking at what the authors write, let's look at how they vote. Did any of the authors sign the petition? No.

I suspect the authors are either still undecided (and cautious), or they believe that time inconsistency in monetary policy really isn't that big of an issue. After all, they have 71 equations that prove it.

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