Ken Rogoff is one smart guy and his writings are typically fun to read. His latest piece, however, left me feeling a little disappointed. It concedes too much to the "balance sheet" view of recessions which for reasons spelled out here and here is an inadequate view of the crisis. Moreover, his analysis ignores what monetary policy is really capable of doing for the U.S. economy: increasing nominal spending and nominal incomes. Ramesh Ponnuru, the resident quasi-monetarist and Senior Editor at the National Review, makes this point:
Well said.Kenneth Rogoff writes that “the only practical way to shorten the coming period of painful deleveraging and slow growth would be a sustained burst of moderate inflation, say, 4-6% for several years.” It certainly would be a way to reduce the real burden of debt, but is it the only or the best way?
The Federal Reserve has more direct control over nominal spending/nominal income than it has over inflation, and higher nominal income—whatever the ratio between the higher inflation and higher real growth that compose it—makes it easier to pay down debts (most of which are contracted in nominal terms). Because of wage stickiness, at least some of any increase in nominal spending that the Fed generates will take the form of real growth—and obviously one would prefer that portion to be as large as possible.
What we need, then, is not more inflation. We need for the Fed to stop holding the money supply below the demand for money balances. That might increase inflation, which would be a price worth paying to get nominal spending back to trend. But inflation shouldn’t be the goal.
Update: Marcus Nunes makes a similar point here.