Last week I wrote a critique at Defining Ideas, a Hoover Institution publication, of the views of Paul Krugman and Olivier Blanchard. Blanchard (pictured above) wrote a brief note defending himself and I wrote back. It went a few rounds.
To recall, I had one critique of Paul Krugman and two critiques of Blanchard. My critique of Krugman was that he was unwilling to admit that the “incomes policy” he seemed to favor was really a system of wage and price controls. My critique of Blanchard was that he talked about inflation without mentioning the growth of the money supply and that he got causation reversed: it doesn’t go from slow the economy to reduce inflation; instead it goes from reduce the growth rate of the money supply to reduce inflation and an effect of that is often a slowing of the economy.
Here’s my back and forth with Blanchard:
Blanchard:
Incomes policies, Wikipedia definitions not withstanding, have nothing to do (at least in Europe) with wage and price controls. They have to do with social partners trying to come to an agreement on how to deal with a particular issue.
On monetary policy. Yes, in general, it can be the source of the conflict, and thus of inflation. In the particular case of the US today, I think fiscal policy is more to blame.
Henderson:
Dear Professor Blanchard,
Thanks for your note.
When I checked the web, what I found is that pretty much every incomes policy was designed to affect prices and wages, usually with controls. Of course, you know Europe better than I do. Your brief comment was a little too brief. What specifically were incomes policies in Europe? Also, you refer to “social partners.” I’m not sure what that means. Could you explain?
Regarding inflation, do you think it would have been nearly as high as it has been if the Fed had not monetized much of the increase in debt?
Best,
David
Blanchard:
Don’t trust the web. 😊
Incomes policies in europe are tripartite negotiations between labor, business, and the government. Most celebrated agreements are Wassenaar in the Netherlands, Moncloa in Spain. And, for a long time, negotiations in the context of the French plan to assess the desirable path for the economy, the appropriate rate of growth of nominal wages and so on. (Agreement on the path of wages is not price-wage controls. Distortions come when there are constraints on price adjustment)
On monetary policy. I believe that the effect of QE has been to decrease long rates by about 100 bps [DRH note: basis points], which is not negligible, but is far less, in terms of effects on aggregate demand than the various fiscal plans, especially the ARP [DRH note: Biden’s America Rescue Plan].
Debt has not been monetized. The Fed has bought long bonds, and issued short maturity, interest paying, reserves. This does not change total debt, and has a minimal effect of interest payments.
Best.
Henderson:
Thanks for your quick reply.
May I use this in a follow-on blog post?
Best,
David
Blanchard:
Sure. Always happy to educate Hoover 😊
Henderson: Lol.
I will probably have more thoughts on his monetary policy point. I think he’s wrong but I’m not sure. Also note that the only transmission mechanism he conceives of from monetary policy to aggregate demand is through interest rates..
And notice that he didn’t reply to my claim that he mistakenly reversed the causation between slowing the economy and reducing inflation. Maybe I’ve educated MIT. I’m happy to do so.
READER COMMENTS
Garrett
Feb 6 2023 at 8:22am
I think Scott Sumner would say “interest rates are not monetary policy”.
Bill
Feb 6 2023 at 12:09pm
I don’t understand Blanchard’s assertion that debt has not been monetized. If Treasury sells government securities to the Fed in exchange for new money, isn’t that the definition of monetizing the debt?
Andrew_FL
Feb 6 2023 at 1:25pm
Blanchard is incorrect that voluntary agreements to limit wage growth will not cause distortions. They may not be “price controls” in the sense of coercive impositions by the government, but they prevent prices from clearing markets all the same-they make prices more “sticky” as modern economists might say.
Larry Phillips
Feb 6 2023 at 4:20pm
I don’t understand Blanchard. Sure, fiscal incontinence “compels” the Fed to purchase a high percentage of new Treasury debt. Also, the Fed offers short-term, interest-bearing debt to commercial banks. However, the Fed is providing the Treasury/USG with the purchasing power to buy goods and services in excess of what could be purchased solely through tax revenues. How is that not monetizing the debt? And how is it not adding to inflationary pressures?
David Seltzer
Feb 6 2023 at 6:46pm
Blanchard said, “Most celebrated agreements are Wassenaar in the Netherlands, Moncloa in Spain. And, for a long time, negotiations in the context of the French plan to assess the desirable path for the economy, the appropriate rate of growth of nominal wages and so on. (Agreement on the path of wages is not price-wage controls. Distortions come when there are constraints on price adjustment).” Agreement on the paths of wages; Hayek said it is pretense of knowledge. No one individual or group can know enough to plan the creative actions and decisions of others.
Scott Sumner
Feb 6 2023 at 11:14pm
In my view, it makes more sense to blame monetary policy for the recent inflation, as the central bank is supposed to offset any impact of fiscal stimulus that leads to excessive spending and inflation. The Fed did not do that, indeed they didn’t even try. It wasn’t just that the Fed was doing QE, they also held interest rates far below the natural rate. With an appropriate monetary policy, the Fed could have prevented anything beyond transitory inflation from supply problems. They should have aimed to return NGDP to the old trend line. Instead, they held rates at zero even as NGDP was clearly overshooting that trend line.
There’s no upper bound on interest rates—they could have and should have offset the excessive part of the fiscal stimulus.
Thomas Lee Hutcheson
Feb 8 2023 at 11:07am
Yes!
Fiscal policy for real effects. Monetary policy for monetary effects. [Of course what monetary effects are sought in turn depends o the real effects of alternative targets.]
BC
Feb 7 2023 at 1:46am
What does government do, offer, or demand in a “tripartite negotiation” on the “appropriate rate of growth of nominal wages and so on”? I understand labor offering to work in exchange for some present notional wage and future wage growth and I understand business offering some current wage and future wage growth in exchange for work. However, I don’t understand what government would be offering and asking for in such negotiations. Also, what is “and so on”?
Regardless, suppose labor and business agree to limit nominal wage growth to say 2% per year but the central bank engages in highly expansionary monetary policy. How effective would “incomes policy” be in limiting inflation in the face of expansionary monetary policy? I would think that one would still end up with high inflation due to the expansionary monetary policy and the incomes policy would lead to labor shortages because real wages under the limit on nominal wage growth would be too low. Effectively, incomes policy would prevent nominal wages from reaching equilibrium with rising nominal goods prices. Is government’s role in the “tripartite negotiation” to agree to tighter monetary policy? If so, then I’m not sure why one would need the limits on nominal wage growth. I don’t see why labor and business must offer nominal wage growth limits to get government to agree to tighten monetary policy and, if government were to unilaterally tighten monetary policy on its own, then inflation would fall.
BC
Feb 7 2023 at 2:35am
Here’s one description of incomes policy [https://www.elibrary.imf.org/display/book/9780939934751/ch001.xml]: “The need for incomes policy arises when it appears that a tolerable degree of price stability…can be achieved only at an unacceptably high cost in terms of unemployment, loss of real output, and interference with growth. Hence, incomes policy is often presented as a means of improving the trade-off between unemployment and price stability.”
Suppose a central bank has allowed inflation expectations to become unanchored and powerful labor unions have negotiated high future nominal wage increases in anticipation of high inflation. If the central bank starts to tighten monetary policy but labor and business don’t believe it will follow through, then those high nominal wage growth contracts will make nominal wages way too sticky and real wages too high if the central bank does in fact follow through. The tight monetary policy will succeed in lowering inflation, but the cost in unemployment will be higher than it would have been without the high nominal wage growth. In this case, if government can somehow (?) convince labor unions in “tripartite negotiations” that it really will tighten monetary policy enough to bring down inflation, then perhaps labor unions will agree to lower future nominal wage growth, thus decreasing unemployment when/if monetary policy actually does tighten. I can actually see how this might have worked in Europe, with its powerful unions, during past periods where the central bank had allowed inflation expectations to become “permanently” unanchored. Is this the situation that Blanchard was talking about?
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