Ok this is a bit of pinball intro as I bounced first to the PEF to be greeted by a blog post by Erin Weir recommending we all read Nick Rowe poking at the President of the Minneapolis Federal Reserve with a sharp stick (more on that below).
The President of the Minneapolis Federal Reserve had warned that unduly low interest rates would cause deflation. Of course, anyone with a handle on basic macroeconomics knows that the risk of leaving interest rates too low is inflation.
Ehhem, as everybody ought to know…ceteris paribus “anyone with a handle on basic macroeconomics knows that the risk of leaving interest rates too low is inflation.”
And what is often left out in inventory (introductory) macro is that ceteris paribus is crucial.
If you were to take Japan as your only data set and regress interest rates on the general price level you might be tempted to agree with the Pres. of the Min Fed. If you took Zimbabwe (interest rates and inflation rates only) as your case you would be tempted to argue the same: high interest rates cause high inflation! Neither of course is right. Back from the extremes; what is the relation between low interest rates in NA and the price level right now? There is a group of economists that have been promising, predicting, and now praying for an acceleration in the general price level since 2001. Ceteris paribus so is Erin if he believes that low interest rates ————> inflation. I do not think he does but it sure sounds like it.
Perhaps if intro to macro started with these real world examples they would be better courses. As everyone knows (don’t they?) both inflation and deflation are anywhere and everywhere decidedly more complex phenomena than simple causal arrows running from interest rates to general price levels. NB. Even the case where interest rates cause inflation or deflation they are going to be particular cases. The causal case (general law level) can only be sustained if and only if the economy being investigated conforms to the model. The theoretical model rarely will (and only loosely) so that too would be a particular case from which no general (———>) covering law can be given. Again the Fed Pres is wrong but not simply because he got the standard Macro 101 ass to front. As Nick Rowe notices and then notes.
I notice he has an undergraduate in maths, then went straight into a PhD in economics. My conjecture: I bet he never took Intro Economics, or anything vaguely similar. I bet he waded straight into the mathematical deep end. And so he never really learned economics. So he took the Fisher identity (nominal interest rates = real interest rates + expected inflation), added monetary super-neutrality (equilibrium real rates are independent of monetary policy in the long run), and ran with it. He never distinguished between the equilibrium thought-experiment and the stability thought-experiment. If you explain this in words, as you have to in Intro Economics, you have to get it right.
We should never, ever, let students do this. Yet we do it all the time.
And this is also why we should never frame monetary policy in terms of interest rates. If this guy can’t understand it, maybe some average people will get it wrong sometimes too, and have things going in the wrong direction
Sometimes I despair of my discipline. And for my economy.
None of which seems to have aught much to do with math save for in one sense; like alcohol, the math does a kind of confidence trick .