Robert Hall: The Long SlumpVillain Zero Lower Bound

•The Great Recession: Decline in Aggregate Demand•Excess stock of housing•High consumer indebtedness

•Think deleveraging shock (Eggertsson and Krugman)•Increased financial frictions Credit Crunch

•Self-correcting adjustment•When some sectors decline, need lower real interest rate for other sectors to compensate

Hall’s World Liquidity Constrained Unconstrained

Consumers Consumers C down i down C up

ZLB obstructs self-correction

ZLB A Long SlumpReal interest rate = Nominal Rate – Expected Inflation

• Wither Inflation?– NAIRU is failure … forget about a “natural rate” of unemployment– Inflation responds to u – ulowest in 11 mos

– The good news: after 11 months of slump, no pressure for a drop in inflation rate…we’re not headed for deflation

– The bad news: with unemployment where it is, can’t expect inflation to increase

» Inflation won’t produce a low enough real rate

Hall’s DSGE Model• Cobb-Douglas production function• Cobb-Douglas utility functions:

– Liquidity Constrained Consumers– Unconstrained Consumers

• Search and match job market (DMP)– Worker “pays” for her job– If PV(job) falls, unemployment increases

• Financial sector with zero lower bound– Cost of capital and financial frictions

• Spread that intermediaries earn keeps them from absconding• When intermediary net worth down, it takes a bigger spread friction• Bigger spread heightened threat of borrower default increased cost of intermediation increased credit rationing CREDIT CRUNCH

Results• In absence of ZLB, economy operates at full employment• BUT, ZLB and low inflation “Pinned” real rate Sustained Slump

Lessons from Our Lessons• Romer on Great Depression: Descent and Recovery

(cited by Hall)– Gold standard mindset cruelly high real interest rate– Gold constraint reflation and recovery• Reflation driven by gold inflows, not policy (per Romer)

• The German Inflation– Fixed discount rate (5%) and high inflation Negative real interest rate High employment

Hall on Policy• Fiscal Stimulus?

• It is not that government purchases are ineffective but that government is incapable of executing a rapid and large increase in purchases

• Price level targeting• If inflation lags target, public would expect high inflation as

Central Bank tries to catch up to price target: πe upireal down

• Phased in Value Added Tax (VAT) buy now!• Currency depreciation buy now!• Subsidize consumption until slump ends…then tax• Summers (in context of DMP labor market):

Payroll tax cut small reduction in wage cost big increase in profit margin HIRING