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Today's Must-Must-Read: Simon Wren-Lewis: Do Not Underestimate the Power of Wrong Microfoundations! - Washington Center for Equitable Growth
Newtonian physics lacks internal consistency: The motion of Venus is governed by this strange microfoundation-lacking and absurd “action at a distance”. Astrology possesses internal consistency: The motion of Venus is determined by the Angel of Venus as she beats her wings against the Aether. Newtonian physics is vulnerable to the Lucas critique: without microfoundations, who is to say how the mysterious gravitational “action at a distance” might change if something were to perturb the orbit of Venus? Astrology, by contrast, is invulnerable to the Lucas critique: the Angel of Venus will adjust the force with which her wings beat in order to keep Venus in its proper sphere.
Nighttime Must-Read: Simon Wren-Lewis: Default Panic and Other Tall Stories - Washington Center for Equitable Growth
The more sophisticated defence of austerity… is that there exists a ‘tipping point’ somewhere…. As we do not know where that tipping point is, it is best to stay well away from it…. The problem with this argument is that having your own central bank makes a key difference…. Markets could… begin to suspect default even when there is absolutely no intention within government to let this happen…. But… [with] Quantitative Easing… the cost of servicing government debt does not rise, because additional money is created…. There is no vicious circle. There is plenty of time for the government to take whatever action it wishes to take to reassure the markets…
Nighttime Must-Read: Simon Wren-Lewis: Eurozone Fiscal Policy - Washington Center for Equitable Growth
An additional complication… a country… too competitive relative to the rest of the Eurozone… needs to run a positive output gap… to generate the inflation that will correct that position, and vice versa. For that reason Germany needs a large positive output gap at the moment… therefore a much more expansionary fiscal policy…. So at both the aggregate and individual country level, the inappropriate bias towards fiscal contraction that caused huge losses in the Eurozone in the past continues to operate…
Evening Must-Read: Simon Wren-Lewis: Greece: A Simple Macroeconomic Guide - Washington Center for Equitable Growth
What is one supposed to do when confronted by arguments that seem to me–and to everybody else who has been right about the evolution of the North Atlantic economy since 2008–so unprofessional as this piece in Vox? Simon Wren-Lewis begins the needed labor of Hercules here:
Simon Wren-Lewis: Greece: A Simple Macroeconomic gGuide: “In 2010 periphery Eurozone countries…
Afternoon Must-Read: Simon Wren-Lewis: Endogenous Supply and Depressed Demand - Washington Center for Equitable Growth
Simon Wren-Lewis: Endogenous Supply and Depressed Demand: “Without fiscal austerity the US, UK and Eurozone…
…could currently be at output levels that are above current estimates of potential or natural output…. But are these estimates of potential output really independent of the path of actual output?… We know that stylised view is wrong for a variety of reasons. Labour that has been unemployed may become deskilled. Firms that are forced to cut back on investment in a recession may take time to rebuild their productive capacity. However there may be other ways it is wrong
Afternoon Must-Read: Simon Wren-Lewis: The Divine Coincidence - Washington Center for Equitable Growth
Simon Wren-Lewis: The Divine Coincidence: “The Divine Coincidence is the idea that by controlling inflation…
…we also bring the output gap to zero, so we do not need separate targets for both…. Imagine a parallel universe where the monetary authority targeted the output gap, and not inflation…. In this parallel universe they too had a Great Recession, and (being parallel and all) their recovery was of a very similar shape to ours. How would the output gap-targeting monetary authority in this parallel universe perceive its performance? The story would be one of complete failure. After six years of trying, the output gap had still not been closed. A huge amount of resources had been wasted as a result…. I do not think, in our inflation targeting world, the monetary authorities have this view…. They believe performance over the last six years has not been too bad…. Over the last six years, the Divine Coincidence has been distinctly unholy…. I suspect in thirty years students will look back on this period with the same disbelief that we look back on the 1930s. How could they have allowed the recession to continue for so long, they will ask, when they had the tools to do much better? Part of the answer will be inflation targeting.
Morning Must-Read: Simon Wren-Lewis: Asymmetries and Uncertainties - Washington Center for Equitable Growth
Simon Wren-Lewis: Asymmetries and Uncertainties: “One way to put this point is to go back to the basic rationalisation…
…behind flexible inflation targeting. It is OK to have a target based on inflation alone, with no mention of the output gap, because you cannot in the long run keep inflation at target without also keeping the output gap at zero. This is sometimes called the divine coincidence. However if, at low inflation rates, inflation becomes a noisy, weak and asymmetric indicator of the output gap, then focusing on inflation is going to perform badly. In these circumstances it could be many years before it becomes clear that we have been continually running the economy under capacity, and needlessly wasting resources. Unfortunately even when that point of realisation arrives, for obvious reasons monetary policymakers are going to be reluctant to acknowledge the mistake.
