One question that comes up occasionally in comments is, what would make me change my mind about how the economy works? Associated with this is the question of whether I have ever changed my views drastically in the face of events.
Let me answer the latter question first. I had a major change of views in the late 1990s, driven by events in Asia.
Until then I had pretty much accepted the “elegant, and conceptually simple” framework described recently by Olivier Blanchard. Basically, I thought that...
conventional monetary policy could do the job of stabilizing the economy.
The Asian crisis, however, led me to rethink that orthodox view. It showed, first of all, that a market economy can suffer huge financial shocks that can’t be offset just by using monetary policy; in particular, I found myself seeing a real role for capital controls to deal with the effect of currency crises in countries with large foreign-currency-denominated debt.
And the reality of Japan’s liquidity trap showed that monetary policy can lose traction even without those kinds of currency and debt-denomination issues.
You could say that the Asian crisis made me more Keynesian — because it showed that 1930s-type problems could happen in the modern world, and that you could not, in fact, count on Uncle Alan or Uncle Ben to solve everything. So I came into the 2008 crisis with a framework based on my interpretation of what happened in Asia in the 1990s — a framework that has worked pretty well at making sense of events so far. Meanwhile, a lot of economists who had not taken the events of the 1990s on board were caught flat-footed.
What would it take for me to decide that I needed another major rethink? A major surge in domestically-driven inflation — in particular, a surge in wages — would do it. And there has been an uptick in core inflation measures that is a bit of a surprise; but at this point it doesn’t remotely count as the kind of discordance with theory that would require a major shift.
The point is that yes, I am prepared to change my views when the evidence warrants. Are you?
