You know you're in trouble when even the Italians forget how to inflate
By Scott Sumner
Do bad times make us less smart? It sometimes seems that way. When times are good, people dispassionately explain how you don’t want to overreact to plagues with draconian policies like quarantines, especially if the disease is not highly contagious. During a plague the reptilian brain takes over, and xenophobia becomes highly personal.
During the 1990s the economics profession seemed pretty smart. They had abandoned ideas like bailouts and fiscal stimulus to create jobs, and understood that monetary policy could and should steer the nominal economy. Liquidity traps were only a problem for the stodgy, uncreative Bank of Japan. There didn’t seem to be much difference between top-notch economists such as Greg Mankiw (dismissing the idea that across-the-board tax cuts would boost revenue) and Paul Krugman (defending the exploitation of cheap third world labor.) To be fair, I have no reason to assume either individual has altered their specific views on those two issues. But no one can deny things look very different in the 2010s.
[Update: Commenter Vivian pointed out that at least Mankiw has not changed his views.]
I saw a recent example of the effect of growing pessimism in this story discussing Mario Draghi:
President Mario Draghi said expanding the European Central Bank’s balance sheet is the last monetary tool left to revive inflation although there is no target for how much it might be increased.
“It’s very difficult for me to give you an exact figure at this point in time,” Draghi told reporters in Washington today during the annual meeting of the International Monetary Fund. “I gave you a kind of ballpark figure, say about the size the balance sheet had at the start of 2012.”
To be fair, this statement might be defensible if you define “tool” very narrowly. All the ECB can really do is reduce the demand for base money (negative interest on bank reserves) or increase the supply of bank reserves (QE.) But I don’t think that’s how the markets would interpret Draghi; they’d assume he was saying the ECB is almost out of ammunition. This isn’t just wrong, it’s crazy. The ECB is the monopoly producer of a fiat currency. They can debase it any time they wish. And I’m not just talking about unlimited QE. Switching from inflation targeting to a 1.8% growth rate price level target would be hugely expansionary, far more so than an extra trillion euros of QE. And completely within the ECB’s mandate.
Perhaps Draghi knows all that, but is expressing frustration that the powers that be won’t allow the ECB to do what is necessary. Either way, this is scary for the markets. To eurozone stock investors it doesn’t much matter whether the ECB “can’t” or “won’t” do what’s necessary—either fear drives eurozone equity prices lower. In the world of money, speech is policy. Tighter money in this case. Here’s a recent news video:
Pisani: Stocks drop after Draghi’s sour speech
CNBC’s Bob Pisani reports ECB President Mario Draghi’s comments on rates drove down trading in Europe.
Notice that while we don’t know whether Draghi thought it was a matter of “can’t” or “won’t,” the markets do know. If it was “can’t” there would have been no market reaction. Why should stocks fall on public information? Only “won’t” is “news.”
Because we lack a NGDP futures market, I don’t know what any of this means for the US. TIPS spreads in the US have recently fallen, but that might reflect lower commodity prices due to slowing growth overseas. Stocks have fallen, but much less sharply than in Germany. And don’t forget that more than 46% of S&P500 earnings come from overseas profits. If I had to guess I’d wager than NGDP expectations have fallen in the US, but only slightly.
So far. . . .