Round 8: Responses to Criticisms of Inflation Targeting Policy:Discussion Table

Caroline THOMAS
Trinity College Dublin

I very much appreciated this short argument in favour of inflation targeting but felt that points b and e were contradictory. The author used Walras law to refute point b, whilst using the liquidity trap in point e. Unfortunately, since the liquidity trap is a invention of the Keynsian school, it makes little sense to suggest that Walras law (supply creates its demand) should hold. Indeed, Keynsians would say that monetary policy has no effect whilst, conversely, fiscal policy is very effective. It would appear to me that the government needs to strengthen aggregate demand by improving expectations. In particular a real effort must be made to reassure the public that the pension system will continue to work. Raising health care contributions may be necessary but it has increased uncertainty. Since government debt is now at 140% of GDP fiscal expenditure is constrained, so that it must seek to invest in projects that will yield returns in the future. In my view, supporting entrepreneurial activity will be more effective than government lead growth similar to that lead by the former MITI.

TAKAHASHI Yoichi

Thank you for your comments, and welcome to our policy debate. I think that you would like to discuss the relationship between the liquidity trap and Say's Law, not Walras' Law. Roughly speaking, Say's Law claims that total demand in an economy cannot exceed total supply in the economy or, "supply creates its own demand". As you mention, Keynes denied Say's Law; so these days we do not believe it holds good. On the contrary, Walras' Law says that if a system has n markets and n-1 of them are in equilibrium, then the final nth market must also be in equilibrium. This conclusion is widely used in current macroeconomics. Yet, while Walras' Law in a barter economy is inconsistent with Keynesian unemployment, it is, however, consistent in a monetary economy.

I myself agree that entrepreneurial activity is important for Japanese economic recovery. However, I think macroeconomic policy, especially monetary policy, is also important, as is the endeavor of the Japanese government in order to bring an end to deflation. My policy proposal - inflation targeting with money - financed transfer - is essentially equal to the recommendation that Bernanke kindly made for the Japanese economy (c.f. remarks made by Governor Ben S. Bernanke as published on The Federal Reserve Board webpage). Both are a combination of monetary policy and fiscal policy. Furthermore, they are both economically equivalent to Milton Friedman's famous "helicopter drop" of money.