Q&A on my inflation views

For context, read Tyler (and Scott S.) vs. me on inflation.

1. What if the Fed chairperson explained monetary dominance out loud?

That would mean telling Republicans that tax cuts don’t stimulate and telling Democrats that more government spending doesn’t stimulate. So the Fed chairperson would alienate Congress. Retaliation would likely follow.

How could we distinguish empirically the dose-response model from the autocatalytic model of inflation?

A big challenge is to pin somebody down on how to measure the dose. There are many measures of the money supply to choose from, ranging from a narrow definition of Fedcoin plus currency to a broad definition that includes all financial assets. The current fad is to measure the dose as the difference between the interest rate and “r-star,” which is a mythical interest rate at which the economy is in perfect balance. And here, the choice of which interest rate to compare to “r-star” could vary. Finally, Scott Sumner says to heck with all of these indicators–just look at nominal income as the measure of monetary policy. That threatens to be circular. To be fair, Scott wants to use a market measure of expected future nominal GDP, which removes the circularity. But it also makes it hard to do an empirical study, since we do not have direct measures of market forecasts for nominal GDP–it is up to the investigator to try to find a proxy.

We need to agree on a way to measure dose. I want the dose to be something that the Fed controls pretty directly, as opposed to the measure of money that includes all financial assets or even Scott’s preferred measure of market expectations for nominal GDP. But then you run into the problem that the Fed’s operating procedures have changed periodically, especially with paying interest on Fedcoin.

But if you could agree on a dose measurement a priori (meaning you don’t cheat and look at historical data to try to pick a measure that best correlates with response), then in principle you could look at past experience. What you would be looking for is cases of modest but significant changes in dose. If the conventional wisdom is correct, you should see significant response. If the autocatalytic view is correct, you should see no significant response.

Do you really believe that there is nothing the Fed can do to affect the economy?

Of course I don’t go that far. The Fed could sell $400 billion on bonds tomorrow. Or Janet Yellen could walk into the New York Stock Exchange with a bomb strapped to her waist and blow the whole place up.

But if we stick to normal Fed operations, which are small and gradual, I believe that those are easily absorbed by financial markets without affecting anything important. Obviously, this is an outlier view.

Note that the fact that people believe that the Fed affects things gives it the ability to affect things, just as the fact that people believe that Elon Musk’s tweets matter gives Elon Musk the power to affect stock prices with his tweets. But I don’t think that those effects are very long-lasting in either case.