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Hayek’s Rule and the Productivity Norm

December 30, 2013 in Economics

By John P. Cochran

My replacement at Metro State, Nicolas Cachanosky, continues to write interesting, challenging papers in the Austrian tradition faster than those of us used to the slower pace of retirement can read them. His most recent is “Hayek’s Rule, NGDP Targeting, and the Productivity Norm: Theory and Application.” Cachanosky notes:

The 2008 crisis demonstrated that serious economic imbalances can take place even in the absence of inflationary problems. An important consensus regards monetary policy that kept interest rates too low for too long as a major driver of the financial crisis (Borio & Disyatat, 2011; Diamond & Rajan, 2009a; Hume & Sentance, 2009; Lal, 2010; Leijonhufvud, 2009; Meltzer, 2009; O’Driscoll, 2009; Schwartz, 2009; Taylor, 2009; White, 2008; Young, 2012). The absence of inflation introduces the question of whether price level stability is in fact a good guide to monetary policy.

I have argued elsewhere (Hayek and the 21st Century Boom-Bust and Recession-Recovery) this lesson should have been learned from the dot.com bust:

The first boom-bust of the period, 1995–2000, should have provided evidence that Hayek was premature in de-emphasizing the empirical importance of distortions in the structure of production caused by money and credit creation in a growing economy with relatively stable prices (Cochran, Yetter, and Glahe, 2004, pp. 13–14). A monetary shock which accommodated a produc­tivity shock generated a significant boom as exhibited by real GDP above potential GDP (see figure 1). The resulting malinvestment during this period and its effect on employment are illustrated in figures 2 and 3. The resulting “bust,” at least measured in terms of the cycle impact on GDP, was relatively mild.

The significance of this cycle for the role of monetary policy was perhaps missed because it occurred at the end of the relatively long period of growth and stability known as the “Great Moderation.” This period was a time of better—at least compared to monetary policy of the 1960s and 1970s—but not necessarily good policy (Garrison, 2009). During this period, central banks were heavily influenced by macroeconomic events of the 1970s which seemed to discredit the prevailing neo-classical synthesis/Keynesian consensus. A vast economic literature from the consequent policy effectiveness debate emphasized central bank policies that—at least in the long run—aimed at price stabilization as a dominant policy goal. The Fed, while not explicitly inflation targeting, followed a policy that mimicked a Taylor Rule policy. Garrison (2009) characterizes this as a “learning by doing policy” which …read more


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