*** Continuation of an academic debate

I agree with @ojblanchard1 that price-level determination is at the core of monetary policy and short-run macro. Especially because it is fundamentally different from price-theory classical micro where the price level is indeterminate.
🧵

https://twitter.com/ojblanchard1/status/1692882786099605766

Also like @ojblanchard1 I think nominal rigidities are fundamental. Especially because with limits to acquire, absorb, and process information, there is inevitable disagreement across economic agents that are making nominal choices in units of account.

https://twitter.com/ojblanchard1/status/1692882791539560783

* Why raising interest rates lowers inflation, and usually (but may not) raises unemployment 🧵

When the CB raises nominal interest rates, agents want to save more in nominal vehicles as opposed to real ones. The relative value of nominal vs real must rise. Inflation must fall. This happens as: (i) banks want to deposit more at the CB rather than lend to projects, (ii) investors and firms prefer to park resources in nominal accounts rather than invest them in real projects, (iii) households prefer nominal savings instead of buying durables or others

** What does SVB's failure imply for the Fed hiking cycle?
Bank failures and bailout of large depositors has important implications for financial regulation, moral hazard, and general fairness. Good discussions here and in media.

What about for inflation and monetary policy?
🧵 The rate that banks earn on their deposits at the Fed has risen. But the rate that banks pay to their deposits or savings accounts has not. Market power means banks' interest margin is higher, nice profits, the franchise value rises (see work by @AlexiSavov @schnabl_econ @idrechs

*** Inflation and wages

A long time ago, Jordi Gali, Mark Gertler and Argia Sbordone noted: with sticky prices, inflation is expected to accelerate when marginal costs are temporarily low. Intuitively, costs will rise back, and as they do, firms will raise prices.
🧵1/12 This is sometimes called a New-Keynesian Phillips curve (not quite accurate as this is the optimal pricing condition from firms, no GE to link to real activity)

E_t ( 𝛽 𝜋_{t+1} - 𝜋_t) = - 𝜆 rmc_t
(all variables are deviation from steady states)

2/12
ideas.repec.org/a/eee/moneco/v…

*** The original sin of QE (and QT)

QE policies, adopted by the most central banks in the last 15 years, suffered from a sin at birth. This came back to bite this Thursday in the UK.

Confusingly, there are three distinct policies that go under the name of QE.
🧵 [1/15] QE type 1 is increasing the deposits of banks at the CB. It happens when the CB borrows from banks, by issuing reserves, which are the most liquid asset in the economy. The goal is to increase liquidity in the private sector. It is about the size of the liabilities of the CB.

** Inflation: some optimism from expectations data

The data from surveys of inflation expectations in the second half of 2022 will be very informative to distinguish three theories. They have important implications fo what inflation *will be*.
🧵

https://twitter.com/R2Rsquared/status/1553410950157459461

The “ignore it” view is that inflation expectations do not matter and are useless to predict inflation. That view took a serious beating in 2021-22. Those who dismissed the expectations data badly missed the 2021-22 run-up in inflation.

https://twitter.com/R2Rsquared/status/1444696271835570181

** Evaluation of Powell’s speech today in light of the recent past

How does the 2022 Jackson Hole match up with my diagnosis three month ago of how and why 2021-22 monetary policy allowed inflation to rise?

Very well. 4-4.5 out of 5 grade.

I highlighted 4+1 factors.
🧵

https://twitter.com/R2Rsquared/status/1553410950157459461

My 1⃣: having all supply shocks feed 100% to higher inflation and zero to output
JP: "overarching focus right now is to bring inflation back down" "reducing inflation is likely to require a sustained period of below-trend growth" "the unfortunate costs of reducing inflation"
✅

** Is it my fault that my head is wet? 🌧️

A strong recovery, fiscal stimulus, supply bottlenecks, Russia's invasion, energy crisis. Surely they are the causes for why inflation is high? Therefore, it is not the central banks’ fault!

Yes but no 🧵

https://twitter.com/R2Rsquared/status/1553410950157459461

If it suddenly starts raining, and my head gets soaking wet, it was the rain that caused it. Not my fault?

Well, it turns out I had an umbrella ☔️. I chose not to open it. Even if I did it for good reasons, and even if the umbrella wasn't perfect, it is my fault I got so wet.

** The burst of high inflation in 2021-22: How and Why?

I just released a paper based on several talks I’ve given over many months (starting with Markus Academy @markuseconomist and ending with @BIS_org) on why monetary policy did not stop inflation rising in 2021-22 🧵 The focus is on advanced economies and the examples come from the @federalreserve and the @ecb. I highlight 🔢 factors, which I think were central. They are not exclusive, and I hope are broad enough to include other views in the public debate, with different weights on each one

** Blaming the ECB for an Italian debt crisis?

As the ECB (finally!) raised rates to curb inflation it announced a new bond-buying program. If that fails and an Italian debt crisis follows, is the ECB to blame? Some rough back-of-the-envelope numbers on 🇮🇹 debt fundamentals… 🧵 🇮🇹’s government debt is rougly 150% of GDP. But only about 1/3 of that is due in the next 2 years. Say the ECB raises rates by 3-6% on average over 2 years to fight inflation. Then this costs 3-6% x 50% = 1.5-3% to the 🇮🇹 Treasury. 🧵

*** For Europe, more is at stake today

One week of economic sanctions is not enough to assess their full impact. But it has been enough time to see they are not enough to stop the war. The next step is clear: European countries should stop buying Russian oil and gas on Monday🧵 Two years ago, governments ordered us to lockdown at home. It was worth it, to fight the virus, and to defend public health.
To fight the virus of totalitarianism and defend freedom it is worth it to lock-down *all* Russian exports to global markets. More is at stake today

One part of the Fed’s announcement last week had me scratching my head. 🧵

It “unanimously reaffirmed its Statement on Longer-Run Goals and Monetary Policy Strategy. The reaffirmed statement is identical to the version initially adopted in August 2020.”

federalreserve.gov/newsevents/pre… That 08/20 statement set out flexible average inflation targeting, where the Fed will seek inflation that averages 2% as measured by the PCE deflator over an unspecified horizon

federalreserve.gov/monetarypolicy…

*** We are all doves now 🧵

Most hawkish speak from the most dovish Fed (in speak and actions) puts you where?

To get a sense of how dovish the FOMC today is, focus on the longest serving member: Charlie Evans, president of the Chicago Fed. Here is what he said in October 2011:

https://twitter.com/michaelsderby/status/1484231673776644102

"Imagine that inflation was running at 5% against our inflation objective of 2%. Is there a doubt that any central banker worth their salt would be reacting strongly to fight this high inflation rate? No, there isn’t any doubt. They would be acting as if their hair was on fire."

** The “macro” view on 2021 inflation
Since March 21, I've given many public lectures on inflation. All of them included the slide below (most recently at the Jahnsson prize lecture)
Tldr: every macro theory of inflation correctly predicted the high inflation that we have seen🧵 The 1st theory (Phillips, Keynesian) sees inflation as following from the closing of gaps in labor and product markets. Given how quickly the economy was rebounding already at the start of the year (and partly due to fiscal stimulus), inflation was expected to rise in 2021.

For most surveys of expected inflation, is the median a good statistical forecaster of future inflation? Usually not.
But does this mean that expected inflation does not matter to understand inflation? Absolutely not.
Forecasting is not the same as understanding, or mattering. The classic example are stock prices: they can be completely driven by fundamentals, and yet be close to unpredictable
Also, when an applied micro paper finds that x matters for y, it never claims/worries that x is a terrible forecaster of y. Nor should it
bit.ly/2ZMmJIl

Start from the classical model in micro 101, the foundation of modern econ. A fundamental result (going back centuries) is that inflation is indeterminate. That means that if people expect inflation of 100%, inflation will be (close to) 100%. Why?
doi.org/10.2307/3440167 If everyone expects prices to double, everyone sets their [prices / wages / any choice in £s] to be twice as high. But then prices double, just as people expected. Expectations are (almost) *all* that matters for inflation, and they can be anything.
doi.org/10.1086/696050

If people pay attention to everything and know it all, they don't need to form expectations of inflation: they just know it. However, information is incomplete, and we have limited attention. So, we make predictions based on a limited set of information
ideas.repec.org/h/eee/monchp/3… Theories of attention are theories where people choose whether to spend some scarce resource (time, money, brain capacity) to expand their set of information. With it, they update their expectations. This change in beliefs makes them change some actions.
ideas.repec.org/p/cpr/ceprdp/1…

I’ve just been catching up with Jackson Hole’s symposium. It had some great papers. But, of course, the attention went to Jay Powell’s speech. Most people liked it. But, reading it today, the speech has made me nervous about US inflation. Here is why. 🧵
ft.com/content/ced452… I mostly agree with Powell that (1) much of the recent increase in inflation is relative prices not pure inflation, (2) these price changes seem temporary, (3) no pick up in wages so far, (5) global forces are favorable. But not with his discussion of (4) inflation expectations.

During my Lamfalussy fellowship at the @BIS_org, I wrote a paper for its annual conference on “The constraint on public debt when r < g but g < m”.

A short thread on economic policy implications from the paper. (Ungated at bit.ly/3m2BmOX)

1/14
cepr.org/active/publica… The bread-and-butter of analyses of whether the public debt is sustainable is the government budget constainrt:

Public Debt + PV(govt purchases + transfers) = PV(tax revenues)

(PV is for present value using a discount rate.)

2/14

** MMT is the new supply-side economics
Forty years ago, some economists started from an uncontroversial (but important) result: a lower tax rate raises the tax base, so revenues won't fall as much. But then they ran with it, predicting tax rate cuts could raise revenues.

1/13 The 80s supply-siders went to the limit and came up with a motto: lower taxes will lower deficits as a norm, not an exception. Many economists shouted this was backwards. It was an implausible limit case. Textbooks called them "charlatans and cranks" or "silly".
2/13

*** What is automatic about the automatic stabilizers?

The discussion on the US extending the extra $600 in unemployment benefits has been couched in terms of automatic stabilizers. But if Congress needs to do something about it, how is this automatic?
on.wsj.com/33qIhdj The CARES Act was a discretionary policy; why is repeating it now automatic? The Act by law expires now; isn’t extending it the opposite of automatic?
Like many other non-boring economic concepts, “automatic stabilizers” is used to mean different things
bit.ly/2EIYi42