Collecting for myself some blog posts on the Neo-Fisherite “rebellion” as Noah Smith calls it. I hope to come back to this later.
Starting with Smith’s own post which collects a lot of this.
First, the basic idea. The Fisher Relation says that nominal interest rates are the sum of real interest rates and inflation:
R = r + i
That’s not an assumption, that’s just a definition (actually it’s an approximation, but close enough). What I call the “Neo-Fisherite” assumption is that in the long term, r (the real interest rate) goes back to some equilibrium value, regardless of what the Fed does. So if the Fed holds R (the nominal interest rate) low for long enough, eventually inflation has to fall. This is exactly the opposite of the “monetarist” conclusion that if the Fed holds R very low for long enough, inflation will trend upward.
Scott Sumner’s response. He does not agree, though I see this bit as interesting:
Suppose a madman is put in change of the Fed who is committed to zero rates over the next 10 years, come hell or high water. Then I might forecast an upward drift in inflation; indeed I think hyperinflation would be quite possible. It depends on what else the madman did. But if you simply told me that rates would be low over the next 10 years under Janet Yellen, I’d assume that inflation would be low, and that low inflation is precisely the reason why Yellen held rates down.
Emphasis in original
Ryan Avent writes in Free Exchange blog for the Economist
Try this. Imagine the Fed sets the interest rate it pays on banks’ excess reserves to 20%. This would immediately cause the economy to fall into deep depression. Banks would liquidate their loan portfolios and raise deposit rates in order to maximise their excess reserves. Consumers would liquidate their asset holdings and put everything in bank deposits since, as Mr Smith notes, there are very few investments in an economy that can deliver a 20% return. It would be the mother of all credit crunches.
But after that, the Fed would be pumping money toward banks, and on to depositors, at a pretty rapid clip, in keeping with the 20% interest rate. Depositors would be getting richer much faster. Those that wandered into the smoking rubble of the economy would soon find prices rising, as this rapidly growing money supply competed for limited goods (even more limited than normal, since the destruction of the credit system would be a nasty supply shock). The Fed’s action would—eventually—deliver rapid inflation.
And Simon Wren-Lewis adds more with a specific focus on the Zero Lower Bound.
I wondered whether we could give the ZLB steady state a different interpretation? Suppose agents believe that is where inflation is heading because they do not think monetary (or any other) policy is capable of achieving the inflation target. Given current attitudes to fiscal policy, and a pessimistic view of the power of QE, this interpretation does not seem so farfetched for the US or UK. Economists sometimes worry about a deflationary spiral, where inflation just keeps falling into a bottomless pit. But maybe the ZLB steady state is like a ledge that can stop this descent.