Stagnation and Monetary Policy

I strongly agree with Ryan Avent that monetary policy has likely played a larger role in generating some problematic long-term economic trends than people generally realize.

The best evidence for this proceeds by way of analogy. In general, a person doesn’t want to overeat and get fat or under-eat and starve. And it used to be that people would generally fluctuate above- and below-target. Indeed, humans evolved to get into the habit of over-eating when food is plentiful precisely because food is bound to be scarce in the future. But in today’s rich countries, starvation basically never happens. That’s a good thing. But it means that most people alternate between days where they eat enough food and days where they eat too much food. Consequently, the trend is toward people getting fatter. This constitutes a clear improvement over a regime of sporadic dearth and starvation, but it has led to some problems.

Similarly, until 1980 or so the economy sometimes had bouts of inflation that the Fed had to control by raising interest rates and throttling growth. Since 1980, that’s never really happened. Consequently, the boom/bust cycle now alternates much less frequently than it used to. But the Fed obviously hasn’t learned how to prevent recessions from happening. We had a severe one around 1990, a mild one around 2000, and a very severe one just recently. The problem here isn’t that eliminating the inflation problem is a bad thing, any more than eliminating period of dearth is a bad thing. But if people never go hungry and sometimes overeat, the result will be rising obesity. If the economy never overheats but sometimes underperforms then average unemployment rates will be higher (which, as you can see above, is the case) and workers who lack unique skills will suffer.

That doesn’t explain all our problems, but it does explain some of them. The decision to become lopsidedly inflation-averse wasn’t undertaken for no good reason—the late seventies happened—and it’s been uniform across the developed world. What’s more there’s some reason to think that it’s a problem that gets more severe over time since low nominal interest rates during expansions seems to make it difficult for unduly unimaginative central banks to fight recessions.