Noted for August 30, 2013
Whiskey Tango Foxtrot Kansas City Bang Query: 102F @ 5:30 PM

A Comment on a Talk by Warren Mosler...


In the Tinbergen setup, we have two instruments--fiscal policy and monetary policy--and three targets: full employment, price stability, and a stable debt trajectory.

Abba Lerner's intuition back during World War II--which he developed right here in Kansas City--was that there was some sort of "divine coincidence" by which there was at least one combination of fiscal and monetary policy that achieved full employment and price stability and yet also had a stable debt trajectory.

Lerner's argument was essentially an argument by construction. Pick fiscal and monetary policies that produce full employment and price stability. Look at the debt trajectory. If the debt trajectory is unsustainable, then ease monetary policy by some amount {delta}M and tighten fiscal policy by some amount {delta}G in order to keep output at potential, and thus produce no additional upward pressure on inflation. The easing of monetary policy reduces interest rates on the outstanding debt; the tightening of fiscal policy reduces the flow deficit; the net effect is to reduce the slope of the debt trajectory. Look at the debt trajectory again. Is it sustainable? If not, tighten fiscal policy and ease monetary policy some more. Continue this process until the debt trajectory is no longer explosive.

A disproof of Lerner thus seems to require that you reach a point where there is (a) full employment, (b) price stability, (c ) an explosive deficit path--but that (d) you cannot then tighten fiscal policy because the political system won't let you. Thus the debt continues on an explosive nominal path, and that explosive nominal path sweeps price stability away with it.

On this interpretation, at least as long as we stay within the Lernerian universe, it is possible to make arguments that we have to settle for a sub-full employment economy now because of the burden of outstanding debt. But such arguments seem to require (i) a belief that the political system will not allow a sufficiently countercyclical and tight-enough fiscal policy when we reach full employment, (ii) so we cannot run a sufficiently countercyclical and loose-enough fiscal policy now, and (iii) our monetary policy options are very limited once we hit the ZLB.

Is there another way to break Lerner's argument as long as we believe in the accelerationist Phillips curve--as long as we believe that full employment also produces inflation outcomes equal to inflation expectations?