Sunday, 13 October 2013

Counter cyclical measures work better if they are announced as permanent: um – er – that’s a contradiction in terms.

Scott Sumner argues that a monetary base increase will have a stimulatory / inflationary effect if it’s accounced as PERMANENT.
No doubt. But the problem there is that any announcement by a government or central bank to the effect that a counter cyclical measure is permanent is a contradiction in terms. It won’t be taken seriously.
A counter cyclical stimulatory measure is one which by definition may be reversed if and when the private sector gets too confident. It’s a bit like the recent announcement by the Bank of England that interest rates will stay low for two years: no one believes it.

Of course the same problem applies to fiscal stimulus: i.e. the effect of ANY stimulatory measure, monetary or fiscal, is always reduced by income smoothing.

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