Updating prior beliefs
The New York Times has a piece discussing how two famous economists updated their beliefs on the efficacy of monetary policy in response to new information. First Narayana Kocherlakota:
“It’s a little embarrassing to say this, but you make a speech in August of 2010 and it inspires a whole quantity of work where people say, ‘This is what Kocherlakota says and we will now show in this paper that Kocherlakota was wrong,’ ” he said. “There’s a number of ways that people can react to that, and I reacted in the only way that a sensible person can, which is to update.”
In September 2012, shortly after the Fed announced a fresh expansion of its stimulus campaign, Mr. Kocherlakota returned to Michigan’s Upper Peninsula to announce that he had changed his mind. Contrary to his prediction, inflation was slowing. That meant the Fed had the opportunity and responsibility to do more.
Right now he’s the only one at the Fed arguing publicly that they should do more (according to the NYT.) That makes him my favorite government official.
Before discussing the second example in the NYT piece, a bit of background information. Edward Prescott played a pivotal role in developing real business cycle theory in the late 1970s and early 1980s. Prescott claimed that monetary shocks did not have significant effects on real output. At about the same time both monetarist and Keynesian economists were arguing that if the Fed brought the rate of inflation down rapidly, unemployment would soar much higher in the short run. The monetarists claimed unemployment would later fall back to the natural rate, even if inflation stayed low. The Keynesians were less sure about that.
In 1981-82 the Volcker Fed did bring inflation down very sharply, and unemployment soared to 10.8%, the highest rate since 1940. How did this event affect Prescott’s views? This is from the same NYT column:
Edward C. Prescott, who won the Nobel in economic science in 2004 and is on the Minneapolis Fed’s research staff, said Mr. Kocherlakota was misjudging the Fed’s abilities. “It is an established scientific fact that monetary policy has had virtually no effect on output and employment in the U.S. since the formation of the Fed,” Professor Prescott, also on the faculty of Arizona State University, wrote in an email. Bond buying, he wrote, “is as effective in bringing prosperity as rain dancing is in bringing rain.”
Well that settles it.
Speaking of rain dancing, I used to think Kocherlakota was of Native American descent. Not so:
Correction: January 27, 2014
An earlier version of this article misstated where Narayana Kocherlakota was raised. He was raised in Winnipeg, Manitoba, not Calgary, Alberta. It also misstated the age at which he received his doctorate. He was 23, not 24.
Because of an editing error, the article also misstated the origin of Mr. Kocherlakota’s name. His name is Indian, not American Indian.
HT: Saturos, Michael Byrnes