But that's by the by. I've been intrigued by the debate the last few days about a speech by Narayana Kocherlakota, who is the President of the Minneapolis Fed (part of the US central banking system). The point that has generated the debate is this:
To sum up, over the long run, a low fed funds rate must lead to consistent—but low—levels of deflation.So someone very high up in the US Central Banking system is making the point that low interest rates must (not might, or could) lead to deflation (that's negative inflation). This is, of course, counter to most folks' intuition - at least folk who have studied monetary economics at a basic level. There, we teach that lower interest rates encourage investment and discourage savings, hence raising aggregate demand. With higher aggregate demand, one expects inflation to be the result of low interest rates.
Hence, perhaps unsurprisingly, a number of people are frothing at the mouth: Paul Krugman, Scott Sumner, Nick Rowe, Mark Thoma and Andy Harless, to name but a few prominent US economists and bloggers. I'd say it's interesting to have a read of most of these links - particularly the one for Nick Rowe as the comments there are particularly extensive. Andy Harless has perhaps the most humorous take: Kocherlakota it seems has mistaken "must lead to" with "are a result of", and hence Harless suggests that perhaps umbrellas cause rain.
Now of course the blogosphere is full of such strongly put opinions, and I suspect the most widely read blogs are those that are particularly forthright and strong in how they put forward ideas - rather than the mild-mannered blogs that don't say anything particularly strongly.
The other side of this can be found in the comments on Nick Rowe's blog from two people: Steven Williamson and David Andolfatto. Williamson is a particularly forthright economist, and spends most of his time bashing Paul Krugman. I used to teach a module for which the textbook I inherited was his textbook. If I was still teaching that module, I would have dropped the textbook by now, simply because of the outright hostility he holds to all schools of thought other than his own, and the associated intellectual arrogance he exudes in all posts.
The essence of Williamson's response is that of course you can put together a model which explains the statement Kocherlakota wrote. That's the standard economist's response. And because he can think of a model, then he decides he has to mock and deride all those who don't subscribe to the simple model he wrote down.
Of course, what isn't answered by Williamson is the empirical relevance of the model. Does his mini-theory have any relevance whatsoever in the real world? (in economist-speak is it empirically relevant?). The model he puts forward makes one particular assumption that stands out: Prices move freely. So prices aren't sticky at all. This is a standard debate amongst macroeconomists, would you believe - whether prices are sticky or not. Forget shoe-leather costs, wage contracts, etc., all the obvious empirical evidence for sticky prices. Some people, like Williamson reject that prices are sticky - on intellectual grounds, not empirical ones. Williamson finds the theoretical underpinning arguments for sticky prices unpersuasive, and so therefore these sticky prices can't possibly exist.
So basically we're left with a debate between people who look at the world, see the frictions and issues with the economic mechanism and design models that represent these problems and hence draw conclusions likely relevant for policymakers, who draw the conclusion that low interest rates in general should not be synonymous with deflation, and others who take a theoretical view of the world starting from the premise it functions just perfectly (I don't see a good reason why sticky prices exist therefore they don't). In the latter world, which bears no relation to the real world, it is possible to defend the initial umbrellas-cause-rain position of Kocherlakota. In the former world, it really isn't possible. I'm firmly in the former world.