One question that comes up occasionally from readers is: What would make me change my mind about how the economy works? Associated with this is the question of whether I have ever changed my views drastically in the face of events.
Let me answer the latter question first. I had a major change of views in the late 1990s, driven by events in Asia.
Until then I had pretty much accepted the “elegant, and conceptually simple” framework described recently by Olivier Blanchard, chief economist at the International Monetary Fund, on the organization’s Web site. Basically, I thought that conventional monetary policy could do the job of stabilizing the economy.
The Asian crisis, however, led me to rethink that orthodox view. It showed, first of all, that a market economy can suffer huge financial shocks that can’t be offset just by using monetary policy.
In particular, I found myself seeing a real role for capital controls to deal with the effect of currency crises in countries with large foreign-currency-denominated debt.
And the reality of Japan’s liquidity trap showed that monetary policy can lose traction even without those kinds of currency and debt-denomination issues.
You could say that the Asian crisis made me more Keynesian — because it showed that 1930s-type problems could happen in the modern world, and that you could not, in fact, count on Alan Greenspan or Ben Bernanke, his successor at the Federal Reserve, to solve everything.
So I came into the 2008 crisis with a framework based on my interpretation of what happened in Asia in the 1990s — a framework that has worked pretty well at making sense of events so far. Meanwhile, a lot of economists who had not taken the events of the 1990s on board were caught flat-footed.
What would it take for me to decide that I needed another major rethink? A major surge in domestically-driven inflation — in particular, a surge in wages — would do it.
And there has been an uptick in core inflation measures that is a bit of a surprise; but at this point it doesn’t remotely count as the kind of discordance with theory that would require a major shift.
The point is that yes, I am prepared to change my views when the evidence warrants.