Krugman’s blog, 4/21/15, 5:53 AM

There was one post yesterday, “The Stability Two-Step:”

Yes, I’m wide awake at a ridiculous hour thanks to jet lag. Why do you ask?

A couple of weeks ago Ben Bernanke wrote a detailed takedown of … somebody, who has been arguing that money should be tighter even in a depressed economy, so as to safeguard financial stability. It was actually about John Taylor and maybe the BIS. Now Tony Yatesgoes after Taylor much more directly. This is all good stuff — but I wonder whether it’s making the issue more complex than it needs to be.

The thing that strikes me about the financial stability group is that they are all permahawks. Taylor and the BIS have often argued that money is too loose; have they ever, at least in the past two decades, argued that it is too tight? Not that anyone has noticed.

But if monetary policy is too expansionary on a sustained basis, surely we expect to see accelerating inflation. And there have in fact been repeated warnings from this group that inflation is about to take off. But what we see instead is this:

You might expect some rethinking, given this absence of inflationary trouble to materialize. But the only rethinking that seems to happen is a search for new reasons to make the same complaints about loose money. Inflation is still perpetually looming — no argument is ever abandoned — but now loose money is also a danger to financial stability.

As Yates suggests, this is especially strange when it takes the form of attributing the financial crisis to deviations from the Taylor rule. That rule was devised to produce stable inflation; it would be a miracle, a benefaction from the gods, if that rule just happened to also be exactly what we need to avoid bubbles. But even aside from Taylor’s insistence that he, and only he, can offer the One True Rule, the two-step — the ever-changing rationale for never-changing policy — is reason in itself to discount the whole thing.

Let me also add that if it’s really that easy for monetary errors to endanger financial stability — if a deviation from perfection so small that it leaves no mark on the inflation rate is nonetheless enough to produce the second-worst financial crisis in history — this is an overwhelming argument for draconian bank regulation. Modest monetary mistakes will happen, so if you believe that these mistakes caused the global financial crisis you must surely believe that we need to do whatever it takes to make the system less fragile. Strange to say, however, I don’t seem to be hearing that from Taylor or anyone else in that camp.

It’s all very odd stuff. And you should worry a lot about the possibility that one of these days the Fed may be run by people who think this way.

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