Merrittocracy for 2020-10-12: American Political Economy in the Fall of 2020
The Limits of American Recovery: Project Syndicate

Volcker Disinflation Denialism from Gene Fama…—Noted

https://www.icloud.com/keynote/0n4PwgGO6FAEEAqRG6I72oXtg https://github.com/braddelong/public-files/blob/master/grasping-reality/fama-volcker-disinflation-denialism.pdf

.#noted #2020-10-11

Someone who wishes me ill reminds me today that Eugene Fama regularly flunks the Turing Test.

Perhaps I should, rather, say that he is a blank slate, or a Bourbon: Prince Charles de Talleyrand-Perigord said, famously, that the Bourbons of France had “learnt nothing and forgotten nothing”—learnt nothing about the world, and forgotten nothing of the privilege and deferences to which they believed they were entitled, in spite of the fact that they too had lived through the years of the French Revolution and the Napoleonic Empire.

40 years after the Volcker disinflation, and Gene Frame is still claiming that the ability of central banks to shake and transform intertemporal price structures and so massively affect the economy is a trick. Perhaps done, somehow, with mirrors?

There is something for someone to write about how obliviousness and a total refusal to mark your beliefs to market is a road to career success, and intellectual influence. A very strange road. But a road, nonetheless:

Gene Fama: Inflation Is Out of the Control of Central Banks https://themarket.ch/english/inflation-is-totally-out-of-the-control-of-central-banks-ld.2476: ‘Frankly.... This is just posturing. Actually, the central banks don’t do anything real...

...They are issuing one form of debt to buy another form of debt. If you are an old Modigliani–Miller person the way I am, you think that’s a neutral activity: You’re issuing short-term debt to buy long-term debt or vice-versa. That’s not something that should have any real effects....

When we look at it systematically, we don’t see a big effect of Fed actions on real activity or on stock prices or on anything else. That’s why I use to say that the business of central banks is like pornography: In essence, it’s just entertainment and it doesn’t have any real effects…


The best short response is from Paul Romer:

Paul Romer: The Trouble with Macroeconomics https://github.com/braddelong/public-files/blob/master/readings/article-romer-macro.pdf https://web.archive.org/web/20160914200257/https://paulromer.net/wp-content/uploads/2016/09/WP-Trouble.pdf: ‘If you want a clean test of the claim that monetary policy does not matter, the Volcker deflation is the episode to consider...

...Recall that the Federal Reserve has direct control over the monetary base, which is equal to currency plus bank reserves. The Fed can change the base by buying or selling securities….

August 1979… Volcker took over as Chairman…. In month 2, Volcker took the unusual step of holding a press conference to announce changes that the Fed would adopt in its operating procedures.… Fed officials expected that the change would cause a “prompt increase in the Fed Funds rate” and would “dampen inflationary forces in the economy.”…

The Fed aimed for a nominal Fed Funds rate that was roughly 500 basis points higher than the prevailing inflation rate, departing from this goal only during the first recession. High real interest rates decreased output and increased unemployment. The rate of inflation fell, either because the combination of higher unemployment and a bigger output gap caused it to fall or because the Fed’s actions changed expectations.

If the Fed can cause a 500 basis point change in interest rates, it is truly absurd to wonder if monetary policy is important. Faced with the data in figure 2, the only way to remain faithful to dogma that it is not important is to argue that despite what people at the Fed thought, it was actually an imaginary shock that increased real fed funds rate…

Comments