A whiff of inflationary grapeshot - Paul Krugman Blog - NYTimes.com
A whiff of inflationary grapeshot
Greg Mankiw suggests that the Fed respond to the crisis by committing to substantial inflation over the next decade. Great idea, wish I’d thought of it. Oh, wait …
Actually, Greg has arrived at the same conclusion I did more than a decade ago, when I tried to model the problems then facing Japan, and now facing us. As I pointed out back then, the essence of a liquidity trap is that the real interest rate is too high, even when the nominal rate is zero. So the theoretically “correct” answer, if you can swing it, is to create expected inflation, pushing the real rate down.
As I put it, perhaps too glibly, the central bank needed to “credibly promise to be irresponsible.”
The thing is, at the time my analysis was widely treated as somehow wild and crazy, even though it came straight out of an extremely buttoned-down theoretical model. Japan was supposed to suffer for its sins, not inflate its way out of them. I wonder if similar proposals for the United States will receive the same reception.
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