Mr. Yellen on Monetary Policy

In a press conference earlier this afternoon, president Obama made offhand reference to “Mr. Yellen” by which he probably meant Janet Yellen the Vice Chair of the Federal Reserve. But on the offchance that he actually meant Yellen’s husband, the Nobel Prize winning economist, I went looking for his views on central banking.

His 2000 paper “Near-Rational Wage and Price Setting and the Optimal Rates of Inflation and Unemployment” is a fascinating effort to bring a little reality to macroeconomic stabilization policy discussions. The thesis of the paper, essentially, is that when inflation gets low enough many people feel free to ignore it in many situations and business is simply conducted in nominal terms. As inflation gets higher, this behavior becomes more costly and more people need to substitute in a lot of inflation-conscious decision-making which is also costly. What they show is that as long as inflation is low enough to safely ignore, you can get a lot less unemployment and a lot more output if there’s some inflation than if there’s none. Basically a modest degree of inflation makes it easier to give everyone an efficiency wage and reduce job churn. Consequently: “even when only a fraction of wages and prices are influenced by near-rational behavior, there can still be substantial long-run gains in employment from moderate, rather than very low or zero, inflation.”