Getting the Neo-Fisherites wrong
In response to the the Neo-Fisherite view that persistently low interest rates leads to low inflation, Nick Rowe writes that we have to see what happens to the money base in order to determine inflation. He implies that the Fisher Effect has to have an explanation based on the growth rate of the money supply.
My response to him is that the money base is not the important factor. But rather, the portion of the money base that is circulating or is not circulating. and why?
Then Paul Krugman today responds to Nick Rowe showing that the money base can grow and still inflation will not appear by giving the example of Japan. The US is another example too though.
But then Paul Krugman ends his post by saying…
“The neo-Fisherites are flailing about, trying to find some reason why the inflation they predicted hasn’t come to pass…”
Obviously Paul Krugman does not understand the Neo-Fisherites. I for one never claimed that inflation was just around the corner. I have been saying that low and stable inflation is settling in. That is exactly what we have been seeing in the US, Europe and in Japan for a long time.
Inflation is actually indeterminate when the nominal rate stays stable for a long time. The result depends on the inflation environment in the economy. Is there investment? Are real rates expected to fall further as in Germany after WWI? Is labor share falling? Is the government investing heavily? and so forth…
So the arguments against the Fisher Effect seem weird… and not relevant.
You wrote: “In response to the the Neo-Fisherite view that persistently low interest rates leads to low inflation, Nick Rowe writes that we have to see what happens to the money base in order to determine inflation.”
Mr Rowe’s position would be true if inflation was always caused by loose monetary policy.
But I believe that inflation is caused when consumers are flush with cash, and producers can not keep up with demand. So our current low inflation levels, especially on discretionary purchases, are just what I would have expected. We can make this a very complicated issue which requires a volume to explain or we can just accept that sometimes common sense is good enough.
Paul Krugman seems to be assuming that at least some Neo-Fisherites are the same people who have been predicting high inflation. You deny predicting high inflation, thus you say Paul Krugman must be wrong. But perhaps you are just part of the group of Neo-Fisherites who have not made such predictions.
Paul Krugman wrote: “And at the highest level we have the neo-Fisherite claim that everything we thought we knew about monetary policy is backwards, that low interest rates actually lead to lower inflation, not higher. At least this stuff is being presented in an even-tempered way.
But it’s still very strange. Nick Rowe has been working very hard to untangle the logic of these arguments, basically trying to figure out how the rabbit got stuffed into the hat; the meta-point here is that all of the papers making such claims involve some odd assumptions that are snuck by readers in a non-transparent way.”
Perhaps Paul Krugman just can’t see the benefit of the Neo-Fisherite theory if it is not an excuse for the economy not delivering an expected high inflation. Thus his reference to magic.
I totally agree with you…
The portion of the money base as cash circulating really determines inflation. It used to be in times past that excess reserves with a central bank did not exist. They were lent out. But now we see that the money base as reserves is just sitting there in the central bank. So Nick Rowe is missing the “new paradigm” elephant in the room.
And Paul Krugman sees the great post by John Cochrane but does not respond to it. He points instead to papers that are trying to formulate a logic for the Fisher Effect.
But ultimately, inflation is indeterminate if the policy nominal rate gets stuck at whatever level. Then you have to look at the dynamics that may cause inflation or disinflation to understand what inflation will do.
I think it was Steve Williamson who predicted high inflation, but is now seeing how the Fisher Effect causes low stable inflation.
You wrote: “I totally agree with you…”
I confess that I am a little surprised about that because I can not bring myself to accept the Fisher Effect. And apparently neither can Paul Krugman.
In my last comment I quoted Paul Krugman writing “Nick Rowe has been working very hard to untangle the logic of these arguments, basically trying to figure out how the rabbit got stuffed into the hat; the meta-point here is that all of the papers making such claims involve some odd assumptions that are snuck by readers in a non-transparent way.”
That quote leaves me wondering about the nature of those “odd assumptions” in the papers written on the Fisher Effect.
Thinking out loud. You point out that Paul Krugman points to papers that are trying to formulate a logic for the Fisher Effect. It seems natural to me to try to understand the underlying logic or mechanism but not to you. I am beginning to suspect that the fascination with the Fisher Effect is as an idle observation. That the Effect could be the result of multiple factors interacting in the economy but they are not important to the Neo-Fisherites’ use of the Fisher Effect formula. Thus it seems to become a shortcut or generalization which Paul Krugman writes “involve some odd assumptions”.
“the portion of the money base that is circulating or is not circulating. and why?”
I agree, but find this statement ill-formed. Largely because it’s based on an ill-conceived notion of the monetary base, and “is circulating.”
NO portion of the monetary base IS circulating at any moment. Flows only happen over time. The statements you see about “money being ‘taken out’ of the economy” and such are conceptually incoherent.
A better way to think about both these issues: the velocity of wealth.
If M=household net worth, V is, at least roughly GDP/HH Net Worth.
Would love to see that thinking
Check out the post that I just put up on Visualizing the various paths of interest rates and inflation. You will see that the Fisher Effect happens when the slope of the path is greater than 1. It is a common occurrence in economics. You only need to have the right conditions for it. It is not some weird thing that never happens. You only need to have inflation rising alongside nominal rates. You will see this happen at the end of a business cycle. The trick is to use it to your advantage.
You are the master when it comes to money base and what is circulating or not. I see it to the level that reserves are not circulating or being lent out like they used to be in the past. Paul Krugman made the same point in his post.