Do You Remember When Low Inflation Was Good News?

When I was young the US had high inflation, and reports of lower than expected inflation was treated as very good news.  During the long “Great Moderation” the Fed kept NGDP growing at a fairly stable rate of about 5%.  In that environment low inflation was usually viewed as good news because it allowed for more real growth.  But now it’s become bad news:

NEW YORK (Reuters) – Stock futures extended declines after data showed retail sales dropped for the second straight month and U.S. producer prices fell sharply in May.

It was the sharpest decline in the PPI in three years.  If it was caused by more AS, it would be good news.  But the more likely cause is less AD, which might explain the weak retail sales numbers.  Of course David Glasner has provided much more systematic evidence of the way that low inflation has suddenly become bad news during the Great Recession.

People often ask how I can be so confident that market monetarist policies would help the economy.  It’s partly based on all the macro evidence that other economists look at, such as the fact that countries began recovering from the Great Depression when they left the gold standard, even though at the time most people felt monetary stimulus would not help, because the problems were “structural.”  But it’s partly because the markets themselves seem thoroughly market monetarist.  I find it almost comical the way reporters flounder around trying to explain Wall Street’s obvious preference for monetary stimulus.  They talk disparagingly of “another monetary fix” like the stock market was some sort of drug addict.  BTW, newspapers used the same “inflation is a drug” metaphor in the 1930s.  Both then and now reporters are forced to report the obvious fact that markets very much want more of the monetary stimulus that reporters insist will be useless–pushing on a string.

Just yesterday a strong stock market rally was kicked off by Charles Evans comments in favor of further Fed easing.  Just think about that, Evans is not even on the FOMC this year.  If even the tiniest hint of easy money can cause a big stock market rally, just imagine what a bold move by the Fed on June 20th would do!

It’s fashionable for both the left and the right to disparage stock market reactions, because the market is an unforgiving judge.  It’s not liberal or conservative, it’s pro-success.  It’s like a mirror held up to each economist’s pet theory, and the reflection is often very unflattering.  Conservative views that the problem is entirely structural—Wrong!  Liberal views that the Fed is out of ammo at zero rates—Wrong!   Most people can’t deal with reality, so they call the market “irrational.”  Sometimes markets do make mistakes, but it’s far more likely that the theory that conflicts with market reactions is wrong.

More than two years ago I did a post on Greece that is actually far more relevant today.  I’ll just summarize the post below, but I encourage readers who missed it to take a look.  Back in the early 1930s the war debts crisis was obviously causing problems for the US equity markets.  But the reason was unclear.  Was it because of  the fiscal or monetary implications of the crisis?  Then the US left the gold standard in April 1933 and the debt crisis suddenly stopped affecting Wall Street, despite the fact that it continued to have troublesome fiscal implications for the US.  The reason is obvious; the real problem was the monetary implications of the crisis.

I predict that if the ECB adopted 5% NGDP targeting (level targeting) tomorrow, the Greek crisis would continue, but it would no longer have a big impact on Wall Street.  The transmission mechanism is monetary.

Lot’s of people from Bernanke on down keep telling us that a recovery is just around the corner.  I’m an optimist by nature, so I want to believe it’s true.  But then I look at this:

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