James Bullard on Neo-Fisherian economics
By Scott Sumner
James Bullard has a Powerpoint presentation on NeoFisherian economics. It concludes with 8 bullet points; here is the first:
Policymaker conventional wisdom and NK theory both suggest low nominal rates should cause inflation to rise.
Is this actually what they believe? I have mixed feelings. On the one hand IS/LM certainly doesn’t say that low interest rates will lead to higher inflation, rather it says that low interest rates caused by a rightward shift in the LM curve (i.e. easy money) will raise inflation. But on the other hand Bullard is certainly correct that both monetary policymakers and New Keynesians economists often talk as if low rates lead to higher inflation. I’m not sure if they really believe that, or if they are just temporarily “reasoning from a price change”.
In contrast, the Neo-Fisherian view is that low interest rates lead to lower inflation. This view is also an example of reasoning from a price change, and hence is also false. Low rates lead to low inflation only if the low rates are caused by a leftward shift in the IS curve.
The market monetarist view is that easy money leads to higher inflation, and easy money sometimes lowers interest rates and sometimes raises them. Any reductions in interest rates tend to occur in the short run, whereas higher interest rates tend to result in the long run. In addition, it’s more useful to think in terms of causation as going from inflation to interest rates, rather than interest rates to inflation. (The one exception is if you hold the money supply and the IOR rate constant, in which case lower rates are deflationary.)
The simple empirical evidence reviewed here suggests this is not happening even after 6.5 years of ZIRP.
That’s right, and that’s why the conventional view is wrong.
Even if the Fed begins normalization this year, U.S. and other rates will still be exceptionally low over the medium term.
These very low rates may be pulling inflation and inflation expectations lower via the neo-Fisherian mechanism.
That seems extremely unlikely, given that the markets respond to news of a surprise Fed rate increase in a way that suggests the market views this policy as disinflationary.
For now, I am willing to argue that current inflation is low in part due to temporary commodity price movements, and that inflation expectations remain well anchored.
If the neo-Fisherian effect is strong in the quarters and years ahead, however, we will need to think about monetary policy in alternative ways.
But how would we know if the “neo-Fisherian effect is strong in the quarters and years ahead”? What evidence would we look for? Certainly not a correlation between inflation and interest rates, that’s also a prediction of the Market Monetarist model, which relies on the old-fashioned Fisher effect. Instead, we’d want to see evidence that markets interpret unexpected Fed rate increases as inflationary and rate decreases as deflationary.
Don’t hold your breath waiting for such evidence.
PS. I travel to England this weekend, to the Warwick Economics Summit, so blogging will be light.