Some Thoughts on Economic Stability

Recently, Scott Sumner asked, "Is the free market economy stable?" While there are a number of ways to think about this question, economic stability begins with accurate monetary representation. Even though supply side factors can contribute to overall uncertainty, some components of economic stability have been the sole responsibility of central bankers, for the past century.

What has been problematic since the Great Recession, is that the Fed has not openly acknowledged the centrality of the monetary role, for economic stability. Instead, policy makers have allowed important monetary considerations to be derailed by other issues in FOMC debates. In the above linked post, Sumner notes:

Friedman, Hetzel and I all share the view that the private economy is basically stable, unless disturbed by monetary shocks.

I believe that the Fed contributes best to stability, through faithful representation of what the supply side seeks to accomplish. While the supply side can be notorious for contributing to gradual (long term) economic instability, central bankers remain responsible for maintaining monetary conditions for existing general equilibrium in the short and medium term.

So long as supply side conditions do not dramatically change, accurate representation on the part of central bankers (NGDPLT) can maintain stability for both monetary policy and real economic conditions. However, part of the present difficulty is fiscal overreach, in areas where the marketplace could benefit most from additional growth. As a result, too much time investment in knowledge product, has had little opportunity for practical application in the marketplace.

As it became more difficult to generate revenue (from traditional manufacture) for knowledge based services, governments resorted to increased consumer obligations (particularly asset formation), to make up the difference. Unfortunately, central bankers moved to tighten monetary conditions on those same asset formations, even as they moved to stabilize this source for banking interests. If alternate means for services and asset formation are not generated in the near future, long term growth will suffer. Too much knowledge based product is still defined on fiscal terms, which makes it difficult to completely escape the threat of the zero bound in the near future.

Even though central bankers could commit to a level nominal target, they need additional growth capacity - which means real assistance on supply side terms - in order to return to the earlier growth trajectory. Without that help, ongoing deflation is possible. Only remember the zero bound conditions of the Great Depression, and the fact nations can find it easier to resort to war with other nations, instead of "looking inward" to address the economic fallout which results from intractable non tradable sectors.

Long term deflation is always a possibility, when there is an insufficient degree of time aggregate value, to balance other forms of resource capacity. While negative interest rate territory could be a short term solution, the possibility remains that this form of economic maneuever may make little sense to populations as a whole. For long term growth, it is better to bring time value back into balance with other forms of resource value, in order to ensure economic stability.