David Beckworth and Ramesh Ponnuru just came out with a new article on the economic policy debate in the US. Beckworth and Ponnuru lash out against both left and right in American politics. Let me just say that I agree with basically everything in the article, but you should read it yourself.
However, what I find most interesting in the article is not the discussion about the US political landscape, but rather the very clear description of both the Great Moderation and the causes for the Great Recession:
“The Fed did a pretty good job of stabilizing the economy. The result of its monetary policies was that the economy, measured in current-dollar or “nominal” terms, grew at about 5 percent a year, with inflation accounting for 2 percent of the increase and real economic growth 3 percent. Keeping nominal spending and nominal income on a predictable path is important for two reasons. First, most debts, such as mortgages, are contracted in nominal terms, so an unexpected slowdown in nominal income growth increases their burden. Also, the difficulty of adjusting nominal prices makes the business cycle more severe. If workers resist nominal wage cuts during a deflation, for example, mass unemployment results…During the great moderation, people began to expect spending and incomes to grow at a stable rate and made borrowing decisions based on it. But maintaining this stability requires the Fed to increase the money supply whenever the demand for money balances—people’s preference for cash over other assets—increases. This happened in 2008 when, as a result of the recession and the financial crisis, fearful Americans began to hold their cash. The Federal Reserve, first worried about increased commodity prices as a harbinger of inflation and then focused on saving the financial system, failed to increase the money supply enough to offset this shift in demand and allowed nominal spending to fall through mid-2009″
I wish a lot more people would understand this – Beckworth and Ponnuru are certainly not to blame if you don’t understand it yet.
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UPDATE: See this interesting comment on Niskanen and Beckworth/Ponnuru by Tim B. Lee.