But in the 30s, we were mainly talking about ending expectations of deflation, or at most creating expectations of a rise in the price level to where it was before the Depression; remember that even in 1938, prices were well below 1929 levels:
That’s very different from trying to create expectations of inflation looking forward with no actual deflation in our past.
So yes, the US experience of the 30s is useful to consider. But I don’t see how it engenders easy optimism about the effectiveness of quantitative easing now.
So lets start from what we all agree on.
A credible promise to induce inflation will lead to recovery.
Now it would seem that Paul doubts the ability of Fed to actually create this inflation since the high level of unemployment we are facing is inherently disinflationary.
However, isn’t this equivalent to saying “I don’t think the Fed can dramatically reduce unemployment because doing so would require that it do something that would dramatically reduce unemployment and I don’t think the Fed can do that”
Moreover, whatever you think about market rationality, the markets really are key here because the markets set the prices. To borrow a tem from Paul, there is no such thing as Immaculate Depression.
If asset prices do in fact start to rise in expectation of inflation. If real interest rates do in fact turn negative. If the dollar does indeed decline. Then these forces will encourage consumers and businesses to spend because consumers and businesses have to respond to the prices that they actually face, not the prices that we might think fundamentals support.
We saw all of those movements in response to mere talk about QE2. This strongly suggests that the Fed does have the credibility to induce inflation expectations and that prices will respond to Fed promises.