The Beach DRAFT

So close

Krugman, in his prescription of mandated inflation as a cure for Japan's ills, gets so close (LEDR emphasis):

The answer is to make it clear that points earned in the winter will be devalued if held until the summer say, to make five hours of baby-sitting credit earned in the winter melt into only four hours by summer.

So the BoJ is supposed to mandate that 5 winter sticks will only buy the equivalent of 4 by the summer. To mandate inflation. But HOW? The BoJ has ben seeking to create inflation and has failed. Let us say that the Fed in 1979 had mandated disinflaiton without hiking rates. The result would be no result. The key, as the Fed examined in Three Lessons for Monetary Policy in a Low Inflation Era, is credibility. If you are failing to do something, how can you do it by assertion?

The key Krugman has reached the conclusion but does not see it is the word "melts".

Let us say the aviators of the 'forties were set the task of getting from New York to London (3,456 miles) in three hours in order to save the world (the analogy is not totally far-fetched). Most would say the world was finished: they could not make it in less than 4 hours, at the speed of sound. The solution now seems so blindingly obvious that it is hard to conceive of there being any trouble at all. Yet the sound barrier was believed in many respected circles to be impenetrable. Indeed, many died trying. Japan's problems are caused by a similar inability to realise that the zero bound is in the mind.

Leave aside how, for now

In talking of coupons "melting" from winter to summer, Krugman is, without realising it, describing a negative interest rate. If 4 become 5 six months later, that is a 56.25% annual rate ((5/4)2-1). If 5 become 4 six months later, that is a 36% annual rate ((4/5)2-1). His co-operative needs 56.25% rates in autumn, 36% in autumn, for an average of zero.

At this point, almost everyone gives up. Because popsicle sticks can be hoarded, a 36% rate cannot be imposed: they simply go under the mattress, as is the case in Japan. This is actually wrong, as Buiter examines. But, to stay with the analogy, use popsicles as a currency. The author would trade five popsicles in winter for four in summer. I could try to hoard them, but I need a fridge. The BOJ wants me to eat popsicles and starts giving them to me. The first ones I store, the next I store more expensively. Eventually the fridges are full and the popsicles start to melt. I eat them or lose them. Moving the analogy closer to the real world, how can the BoJ achieve interperiodic equivalence of this sort? Currency redenomination (Gesell money) readily fits the bill. Red, winter popscicle sticks are exchanged 5:4 for blue, summer ones in spring and back in autumn. (A sliding scale of smaller, more regular redenomintions would be needed to avoid short term hoarding or spending panics, but the example is artificial: the interest rates used are huge and would, in the real world, cover many annual redenominations of, say, 5%).

William Porter 24th January 2002