Can the anti-inflation reflex be tamed?

But while there are probably elements of truth to the structural story, it cannot explain why unemployment abruptly spiked. For one thing, Kocherlakota’s estimates for the consequences of “mismatch” — he put the impact at about 2.5 percentage points of unemployment, or nearly 4 million out-of-work individuals — are likely too high. Kocherlakota cited as support for his argument the research of a University of Chicago economist named Robert Shimer, but in a recent interview, Shimer described skill mismatch as a long-term process, not a sudden shift. Kocherlakota’s hypothesis was “reasonable,” Shimer said, but he added, “I don’t know of any evidence that [skill mismatch] is really going on at a greater rate than the process of structural change which has been happening since the Industrial Revolution.” Geographic mismatch, meanwhile, might be a factor — but since only about 1 percent of homeowners move for job-related reasons in a given year, that can account for at best a small fraction of the increase in joblessness.

Critics of the “structural” argument have also noted that employment is down across almost all industries, and that, until recently, joblessness was trending up even for college graduates — both symptoms of widespread economic dysfunction, not labor market mismatch. And researchers at the Cleveland Fed recently concluded that the “natural rate” of unemployment — a term coined by Friedman to describe the level of joblessness he believed was built into the economy at a given time — has risen only slightly, to about 5.6 percent; the dramatic increase, they found, is “largely a cyclical phenomenon.”

Even accepting Kocherlakota’s analysis, though, structural factors — in addition to “mismatch,” these include the extension of unemployment benefits, which are believed to modestly push up the jobless rate — can’t explain the whole story. He has estimated that these factors cumulatively account for about 3 percentage points of unemployment, but from April 2008 to August 2010, the rate rose from 5.0 to 9.6 percent. A broader measure of hiring stress — the U-6 rate, which includes workers who are employed part-time for economic reasons, or “marginally attached” to the labor market — also nearly doubled, to more than 17 percent. Thus, even if you believe structural factors that the Fed can’t do anything about are playing a role — as Kennedy did in 1960, when he worried about those mine workers displaced by newer, better machines — doesn’t it make sense to try to do something to create jobs for the rest of the unemployed?

Through a spokesperson, Kocherlakota declined to address that question. Others in his orbit did comment, though. In September, I asked Randall Wright, an economist at the University of Wisconsin who serves as a consultant to the Minneapolis Fed, for his thoughts on the higher-inflation strategy. The idea was “terribly misguided, bordering on ignorant, and probably dangerous,” he replied — the economic equivalent of prescribing leeches for sick patients.

Part of the objection lies in an empirical dispute: in his academic work, Wright has argued that there is a persistent, positive long-run relationship between inflation and unemployment. “Inflation disrupts the exchange process, which is not good for business and job creation,” he wrote me. “That seems relatively obvious.”

But underlying the disagreement is also a different set of calculations about the cost of different economic ills, and a different sense of what policy can accomplish. Even if “by some miracle” inflation could reduce joblessness in the short run — “say, by confusing people into taking a job that is not right for them” — it wouldn’t be worth it, Wright said. Later, he added:

Suppose a [given] increase in inflation reduced growth by even a tiny amount. Once capitalized over several years this dramatically lowers output. Even if it reduced unemployment, this would be terrible. A [given] change in the growth rate is not equal in terms of welfare to [an equivalent] change in unemployment.

At about the same time, Wright’s co-author Stephen Williamson — an alumnus of the Minneapolis Fed who is now affiliated with the Richmond and St. Louis branches — penned a lengthy blog post in which he distanced himself from Keynesian “good-deed-doers.” He was referring to people who tend to believe that “doing nothing in a recession, when unemployment is high and real GDP is low, would be cruel as well as inefficient.” I followed up to ask: does the government have any role in trying to push back against spikes in unemployment?

It “very much depends very much on the circumstances,” Williamson replied. “One can make a case that the principle goal of the Fed should be inflation control, and that they should ignore other things (in part because, once you control inflation properly, you have exhausted the Fed’s ability to do good).” (There is, Williamson acknowledged, legislation that directs the Fed to care about unemployment, but the law is “pretty vague.”) In his initial email to me, Wright had offered a similarly circumscribed policy vision. “The first rule here should be do no harm. Please do no harm,” he wrote. “I do not mean to suggest that I know a first-best fail-safe cure for our current troubles. But I am 95 percent sure it is not leeches.”

Toward the end of our exchange, I asked Wright and Williamson: Aren’t advocates of higher inflation now calling for much the same thing that the Fed chairman urged on Japan a decade ago? If they are wrong, was he, too? Wright replied first: “Bernanke still thinks like the outdated undergraduate textbooks he learned from: he believes, sincerely I trust, that we can increase output and reduce unemployment by printing more currency.”

Outdated or not, that is in fact the logic – we are experiencing a shortfall of demand, and money is in too short supply – that Bernanke and others in the Fed have articulated. In contrast, Kocherlakota’s interpretation of the economy apparently commands only minority support within the bank. So it is hard to say for certain why the Fed’s leadership has not so far moved further away from the anti-inflation instincts that took root in the 1980s.

When Ben Bernanke offered his plan for the Japanese economy over a decade ago, he, like some of those watching him today, was baffled by the failure to act more assertively. “Policy options exist that could greatly reduce these losses. Why isn’t more happening?” Bernanke asked. “Most striking is the apparent unwillingness of the monetary authorities to experiment, to try anything that isn’t absolutely guaranteed to work.” Japan was suffering from “self-induced paralysis,” when what was needed, he said, invoking America’s experience with the Great Depression, was “Rooseveltian resolve” — a willingness “to be aggressive and to experiment,” in the conviction that a solution could be found, pain alleviated, idle resources put to work.

That determination to act when necessary, along with his stellar reputation within the profession, seemed to make Bernanke well suited to lead the Fed during the current crisis. UNC’S Smith, for one, had been willing to be patient. “There was a long while where it felt like, eventually they’re going to tell us” what the plan is. “Maybe there’s an enormous amount going on behind the scenes,” he recalled. But “then it keeps not happening, and it keeps not happening, and there’s a point at which you break — you just break.”