Raise Rates to Raise Inflation

That's what Stephen Williamson is still arguing.

"recent data is consistent with the view that persistently low nominal interest rates do not increase inflation - this just makes inflation low. If a central bank is persistently undershooting its inflation target, the solution - the neo-Fisherian solution - is to raise the nominal interest rate target. Undergraduate IS/LM/Phillips curve analysis may tell you that central banks increase inflation by reducing the nominal interest rate target, but that's inconsistent with the implications of essentially all modern mainstream macroeconomic models, and with recent experience."

Wow. This is fantastic (fantastical?) stuff.

A couple questions for Neo-Fisherians. Both central banks and market participants believe that higher interest rates slow growth and inflation. If, in fact, higher interest rates raise growth and inflation, then, in a booming economy, why don't interest rate hikes and contractions in the money supply lead to hyperinflation? After all, central banks respond to high inflation by raising rates, which they believe will lead to lower inflation. If, instead, inflation goes higher, they will respond again with even tighter money.

Also, interest rate cuts are demonstrated to cause currencies to weaken. We know this, from, among other things, announcement effects using high-frequency identification. The evidence that real exchange rate movements impact the tradables sector is very strong, and merely relies on the theory that relative prices matter, the central teaching of economics. Then, is all of economics wrong, if prices don't matter?

We also know that market participants/the entire financial sector believes that low interest rates are good for the economy and profits and tight money is bad. We know this from market reactions to monetary policy. A series of interest rate hikes would raise borrowing costs considerably, cause the dollar to appreciate (which will affect inflation directly), cause the stock market to depreciate, and generally cause financial conditions to tighten. Thus, once again, to buy the Neo-Fisherian story, you have to believe that prices don't matter. In addition, you have to believe that markets aren't remotely efficient. Thus, you have to give up the central tenets of mainstream economics. Since "the market" believes monetary policy has the right sign, Stephen Williamson could make a lot of money by starting a hedge fund and betting on the "wrong" sign.

Hey, it's worth pointing out that people can disagree about monetary policy. Williamson (2012) says QE is hyperinflationary, while, on the other hand, Williamson (2013) says QE is deflationary. On the third hand, Williamson (2013; blog post) says money is just plain neutral. What's interesting here is that these are all the same Williamsons.

Thus it's worth peering into his intellectual journey.  First, after QE, despite high unemployment and a weak economy, he repeatedly predicted that inflation would rise. When it didn't happen, he changed his mind, which is what one should do. Only, he couldn't concede that standard Keynesian liquidity trap analysis was largely correct. That would be equivalent to surrendering his army to the evil of evils, Paul Krugman. Much easier to venture into the wilderness, and instead conclude, not that inflation wasn't rising despite low interest rates because the economy was still depressed, and banks were just sitting on newly printed cash, but rather that inflation was low because interest rates were low!

Fortunately, not all of Macro went in this direction, as Larry Christiano, a mainstream economist, discusses the Keynesian Revival due to the Great Recession.