Pro Gauti Eggertsson

Because I do research in so many different areas, there is no way I can read all of the papers that I should. After posting “Gauti Eggertson and Miles Kimball: Quantitative Easing vs. Forward Guidance,” I read a selection of Gauti’s papers on topics that especially intrigued me. Here is my reaction. One of my most popular posts has been “Contra John Taylor.” It is a pleasure to be able to begin a title with the opposite of “contra.”  

There are currently two dominant paradigms for studying business cycles and stabilization policy: Real Business Cycle models and Dynamic New Keynesian models without investment (or with investment tamed so that it makes little difference). Gauti Eggertson is a master of the second. But he is more than that. Gauti is a brilliant investigator and expositor of what Dynamic New Keynesian models of this type have to say about the most urgent policy issues in macroeconomics. Let me illustrate using a few of his papers. (His oevre is much too extensive for me to have had time to read it all.)

With “Great Expectations and the End of the Great Depression,” Gauti changed my mind about how the wisdom of Franklin D. Roosevelt’s policies to try to bring the United States out of the Great Depression. Rather than the relatively unfocused experimentation to try to increase confidence that I had pictured, Gauti paints a picture of a systematic and highly-focused set of policies to raise the expectations of inflation in order to loosen the zero lower bound. It is indeed unfortunate that FDR did not pick up on Silvio Gesell’s or Robert Eisler’s timely suggestions of how to eliminate the zero lower bound and use negative interest rates to escape the Great Depression, but given that limitation on policy, a systematic set of policies to raise inflation expectations in order to lower real interest rates by bringing nominal interest rates further below expected inflation was an excellent approach. In many ways, FDR’s policies were just as radical as eliminating the zero lower bound. Gauti emphasizes how shocking it was for FDR to not only go off the gold standard, but also use the fact that dogma said budget deficits would cause inflation in order to raise inflation in a situation where higher inflation was much needed.

In “Was the New Deal Contractionary?” (to which his answer is “No”) Gauti argues that the much derided National Industrial Recovery Act was useful as a way to raise inflationary expectations. And he argues that its explicitly temporary nature was a recognition that ordinarily raising inflation expectations is a bad thing, but under the extraordinary circumstance of the Great Depression when the economy was hard up against the zero lower bound on nominal interest rates, higher inflation expectations could be helpful. Together with “Great Expectations and the End of the Great Depression,” this paper constitutes a major bit of revisionist economic history, countering the generally dim view that many economists have taken of the details of FDR’s policies as anything more than sleight-of-hand confidence-building measures. (Here there is some danger I am projecting onto others my own view before reading Gauti’s papers, but I do not think I was alone in those views.)

Gauti has also taken a lead in applying the same principles he applied to the Great Depression to the Great Recession. A hallmark of his papers is very careful discussion of how they relate to key controversies in the academic literature, and indeed, they go to the heart of some of the biggest issues in the study of business cycles and stabilization policy. Price flexibility and advance anticipation of inflation are often said to be the keys to monetary policy having no real effect on the economy. But along with Saroj Bhattarai and Raphael Schoenle, Gauti argues in “Is Increased Price Flexibility Stabilizing? Redux” that, short of perfect price flexibility, greater price flexibility is likely to be destabilizing. This idea has a long history, but had not been fully addressed within the context of Dynamic New Keynesian models without investment. Along with Marc Giannoni, Gauti argues in “The Inflation Output Trade-Off Revisited” that contrary to the idea that anticipated inflation does not matter, it can matter greatly when raising expected inflation loosens the zero lower bound. The argument is made in a very elegant and clear way.

Gauti explores the idea that something like the National Industrial Recovery Act that would be bad for the economy if kept in place in the long run can loosen the zero lower bound and so stimulate the economy in the short-run further in “The Paradox of Toil.” In general, most things that lower the natural level of output will also create some inflationary pressure that can loosen the zero lower bound. Although “The Paradox of Toil” focuses on workers deciding they want to work less stimulating the economy or deciding they want to work more having a contractionary effect, he points out how the logic applies to a wide variety of other shocks that would affect the natural level of output. This point is extremely relevant to many policy suggestions that were made during the Great Recession. For example, as compared to a tax rebate–or even better, a line of credit from the government–a cut in social security taxes could easily have a contractionary effect as people tried to work more, and the increased labor supply had a deflationary effect.

Gauti has written many articles on other topics beyond the tightly-linked set of issues I discussed above. I had the chance to look at one: “A Political Agency Theory of Central Bank Independence,” coauthored with Eric Le Borgne. Of the papers I read of Gauti’s this is my personal favorite. With great economy and elegance, Gauti and Eric show the fundamental, coherent logic behind the idea that the independence of a government agency can be valuable because it enables the agency to buck public opinion in the short run. It is hard for the public to know if an agency is doing a good job or not. Without some job security, the head of an agency will be afraid to do things that are good but look bad. Moreover, knowing that they will be afraid to do things that are good but look bad, they will have less reason to try to gain a higher level of expertise than the public–since the value of extra expertise is precisely in knowing when something would be good to do even when it looks bad to the public. This is an extremely important article that anyone interested in constitutional issues needs to study.

Update: See Scott Sumner's response to this post "Pro and Contra Gauti Eggertson." Scott argues that nominal GDP, not the real interest rate, is the right summary statistic for the effect of monetary policy on aggregate demand.