Friday, November 7, 2014

Assume a (neo-Fisherite) can opener

Nick Rowe tries to explain the paper [pdf] from Schmitt-Grohe and Uribe. I think I have a shorter version: Schmitt-Grohe and Uribe simply assume their result. They invented a new "lack of confidence shock" with different dynamics that leads directly to the result -- 'confidence' is directly proportional to the nominal interest rate so a higher interest rate brings inflation up and a lower interest rate brings inflation down. Basically, if the central bank sets a higher interest rate in a liquidity trap then people think the economy is going to improve, and, voilĂ , expectations of improvement lead to improvement.

Now I am interested in the neo-Fisherite view where low interest rates lead to lower inflation -- the information transfer model (ITM) gives that result. However the result in the ITM follows from trying to fit data from before the liquidity trap happened -- it doesn't assume different inflation dynamics in a liquidity trap.

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