DeLong-Summers "Simplistic Keynesians" Smackdown Watch: Kenneth Rogoff
Clark and Summers (1982), "Labor Force Participation: Timing and Persistence"

Raghuram Rajan Tries to Smackdown Nominal GDP Targetters

Raghuram Rajan:

Central Bankers under Siege: Ben Bernanke… has gone further than any other central banker in recent times in attempting to stimulate the economy through monetary policy…. Yet progressive economists chastise him for not doing enough…. Raise the inflation target, they say, and all will be well….

An important source of aggregate demand has evaporated. As consumers stopped buying, real (inflation-adjusted) interest rates should have fallen to encourage thrifty households to spend. But real interest rates did not fall enough, because nominal interest rates cannot go below zero. By increasing inflation, the Fed would turn real interest rates seriously negative, thereby coercing thrifty households into spending instead of saving. With rising demand, firms would hire, and all would be well….

[H]ousehold over-indebtedness in the US, as well as the fall in demand, is localized…. Hairdressers in Las Vegas lost their jobs partly because households there have too much debt stemming from the housing boom, and partly because many local construction workers and real-estate brokers were laid off. Even if we can coerce traditional debt-free savers to spend, it is unlikely that there are enough of them in Las Vegas. If these debt-free savers are in New York City… cutting real interest rates will encourage spending on haircuts in New York City, which already has plenty of demand, but not in Las Vegas, which has too little. Put differently, real interest rates are too blunt a stimulus tool, even if they work….

Given the dubious benefits of still lower real interest rates, placing central-bank credibility at risk would be irresponsible….

We cannot ignore high unemployment. Clearly, improving indebted households’ ability to refinance at low current interest rates could help to reduce their debt burden, as would writing off some mortgage debt in cases where falling house prices have left borrowers deep underwater (that is, the outstanding mortgage exceeds the house’s value). More could be done here. The good news is that household debt is coming down through a combination of repayments and write-offs. But it is also important to recognize that the path to a sustainable recovery does not lie in restoring irresponsible and unaffordable pre-crisis spending, which had the collateral effect of creating unsustainable jobs in construction and finance.

With a savings rate of barely 4% of GDP, the average US household is unlikely to be over-saving. Sensible policy lies in improving the capabilities of the workforce across the country, so that they can get sustainable jobs with steady incomes. That takes time, but it might be the best option left.