What Planet Does He Live on? Robert Lucas on Mortgages and Monetary Policy
Perhaps the strangest thing about Robert Lucas's "Mortgages and Monetary Policy" is his insistence that over the past twenty years "if we have learned anything... it is that there is a lot of stability built into the real economy." What planet does he live on? There was not "a lot of stability built into the real economy" in Japan in the 1990s. Nor was there "a lot of stability built into the real economy" in Mexico in 1994-1995. Nor was there "a lot of stability built into the real economy" in Korea, Malaysia, Indonesia, and Thailand in 1997-1998. On this planet, the lesson of the past twenty years is that very small shocks in financial markets can snowball and destabilize the real economy.
I wish we lived on Planet Lucas. But alas! I don't think we do.
The rest of it is almost as strange:
In the past 50 years, there have been two macroeconomic policy changes in the United States that have really mattered. One of these was the supply-side reduction in marginal tax rates, initiated after Ronald Reagan was elected president in 1980 and continued and extended during the current administration.... As a result... steady GDP growth, low unemployment rates and low inflation rates -- once thought to be an impossible combination -- have been a reality in the U.S. for more than 20 years...
Growth was not steady--growth was in fact quite slow and uneven--during the Reagan-deficit years from 1982-1993. The limited data seem to suggest that perhaps a federal budget in rough medium-run balance is important as well. Surely this is worth a mention? If you are going to talk about things that start in 1994-1995, you probably shouldn't date them back to 1981. This is the Wall Street Journal editorial page--and it is a bad intellectual neighborhood. But just because your in a bad intellectual neighborhood is no excuse.
And there is this:
The other [good change] was the advent of "inflation targeting," which is the term I prefer for a monetary policy focused on inflation-control to the exclusion of other objectives...
There are lots of monetary policies focused on inflation-control to the exclusion of other objectives. A gold standard. A silver standard. Some Fisherian commodity-basket standard. A fixed monetary base. A k% per year growth rate for the monetary base. A k% per year growth rate for checking accounts. A k% growth rate for some broader liquidity aggregate. Lucas says he likes "inflation targeting" and then several paragraphs later goes on to reject the inflation targeting framework:
[A] line of argument that seems to me much less compelling... that monetary policy necessarily affects future inflation rates, not the current rate... whatever funds rate target is chosen, all kinds of others forces -- anything that happens to the real economy -- will affect next quarter's rate of inflation, or next year's. So we would like to forecast these other forces as well as possible and take them into account.... [I]nflation forecasting is notoriously one of the squishiest areas of economic statistics. In this situation, it is all too easy for easy money advocates to see a recession coming and rationalize low interest rates. They could be right -- who really knows? -- and in any case we may not know enough to prove them wrong...
The line of argument that Lucas sees as "much less compelling" is nothing other than inflation targeting: that the Federal Reserve should use the information it has to target the inflation rate. If Lucas doesn't like inflation targeting, fine. But he shouldn't try to capture the good reputation inflation targeting has for something he prefers that is not inflation targeting.
In fact, he never tells us what he does prefer: A gold standard? A silver standard? Some Fisherian commodity-basket standard? A fixed monetary base? A k% per year growth rate for the monetary base? A k% per year growth rate for checking accounts? A k% growth rate for some broader liquidity aggregate? All of these differ from inflation targeting because they ask the Federal Reserve to throw away some information because it is not trusted to use it well. One or more of them may well be better than inflation targeting. But which? And why?
