Goldman's 'Unconventional' Inflation Policy vs. Austrian Deflation Endgame

Tyler Durden's picture

An intriguing research note from Goldman's Global Economics team tonight brought up the subject of 'unconventional' unconventional policies and how they ended the 'first' Great Depression. This gentle push towards softening the inflation leg of the Fed's mandate 'stool', while interesting in its own right given Goldman's policy-leading record, reminded us, by contrast, of a paper discussing how deflation is perhaps the more likely outcome when one shifts perspective from Keynesianism to a more Austrian view of the Fed's options. We are not choosing sides but for a quiet evening following a hope-shattering sell-off in risk assets, we thought it worth reflection.

Goldman Sachs: "Unconventional" Unconventional Policies and the End of the Great Depression

  • We argued in last Friday's US Economics Analyst that the Fed retains a number of "unconventional" unconventional options that would entail pushing inflation above the Fed’s "mandate consistent" rate for a number of years through a temporary change in the Fed’s inflation goal.
  • In an interesting paper, Gauti Eggertsson of the New York Fed argues that Franklin D. Roosevelt’s successful implementation of such policy actions in the 1930s – adopting a price level target and combining it with fiscal stimulus – shifted expectations and thereby played a key role in lifting the economy out of deflation and depression.
    Eggertsson's analysis holds two potential lessons for US policymakers in the current context: (1) credible commitment to raising inflation expectations could deliver a powerful boost to the economy, and an effective way to enhance the credibility would be to pair such a policy change with additional fiscal stimulus; (2) commitment to raise inflation to boost the economy is most desirable – and thus most likely – during times when the economy is weak and inflation is below the Fed's target.
  • In Friday’s US Economics Analyst, we explored the Fed’s options for delivering additional monetary stimulus. (See "The Fed’s "Unconventional" Unconventional Options," US Economics Analyst, September 23, 2011.) We believe the Fed is most likely to make further use of the "conventional" unconventional monetary policies already pursued through renewed asset purchases. But the Fed also retains a set of "unconventional" unconventional options that would entail pushing inflation above the Fed’s "mandate consistent" rate for a number of years through a temporary change in the Fed’s inflation goal. Doing so could boost the economy by pushing down real interest rates and by inflating away some private sector debt. Proposals to do so include a higher inflation target, the "Evans proposal," and a price/nominal GDP level target.


Our simulations of a "toy economy" suggest that the boost to the economy from such policies could be sizable if the Fed managed to commit credibly to their implementation. But this would require a delicate balancing act. In the short term, the Fed would need to “commit to being irresponsible.” That is, the real interest rate would only fall if the Fed managed to commit credibly to generating higher inflation in the future. But promising to do so is difficult because the Fed cannot cut the funds rate any further to boost the economy and, once inflation has risen—and real rates fallen to stimulate the economy—the Fed has an incentive to renege on its promise and raise interest rates prematurely. Markets understand this and no short-term benefits might be achieved. In the long run, the Fed would need to return to its usual "responsible" behavior and keep inflation in the "mandate-consistent" range. Although the Fed would again have the funds rate at its disposal to do so, the concern is that a temporary change in the Fed’s inflation goals could lead to a persistent increase in inflation expectations and that a return to price stability would require a prolonged period of tight monetary policy and subdued growth in the future.


In an interesting paper, Gauti Eggertsson of the New York Fed argues that Franklin D. Roosevelt’s successful implementation of such “unconventional” unconventional policies was a key factor in ending the Great Depression. (See “Great Expectations and the End of the Great Depression,” American Economic Review, 98:4, 2008.)

President Roosevelt took office in March 1933 at the height of the Great Depression: real GDP had declined by 13.4% in 1932—pushing the unemployment rate up to 25%—and deflation was running at double-digit levels (see exhibit below). Conventional monetary policy, however, was powerless as short-term nominal interest rates were stuck near zero (see exhibit). With negative inflation rates, real short-term interest rates—both ex-post and ex-ante—were therefore sharply positive, acting as a further drag on activity. (The ex-ante measure of the real interest rate is taken from a paper by Stephen Cecchetti, who estimates inflation expectations from available data on prices, interest rates and money growth. For details see “Prices During the Great Depression: Was the Deflation of 1930-32 Really Unanticipated?” American Economic Review, 82:1, 1992).


The Economy Climbed Out of Depression after 1933, As Real Interest Rates Declined Sharply


In this environment, President Roosevelt implemented two radical new policies. First, he abolished the gold standard in 1933—giving the administration unlimited power to print money—and announced the objective of inflating the price level to pre-Depression levels. That is, he adopted a price-level target that was designed to raise inflation for a number of years. Second, Eggertsson argues that President Roosevelt abandoned prior balanced budget principles and sharply expanded federal spending by running record-high budget deficits. Between 1932 and 1934, federal consumption and investment spending almost doubled.


Eggertsson shows that this policy regime change was key in breaking out of the Great Depression by affecting expectations about future policy: the adoption of price level targeting was a commitment to raise inflation and fiscal stimulus made this commitment credible. That is, the cooperation of monetary and fiscal policies shifted expectations from “contractionary” (the private sector expected future economic contraction and deflation) to "expansionary" (the private sector expected future expansion and inflation). Although short-term nominal interest rates continued to be stuck at zero, inflation expectations rose and real interest rates declined sharply after 1933 (see exhibit above). At the same time, the economy received a boost and the economy climbed out of deflation (see exhibit).


We can draw two potential lessons from Eggertsson's analysis for US policymakers in the current context. First, credible commitment to raising inflation expectations could deliver a powerful boost to the economy and the best way to enhance the credibility of any such commitment would be to pair a temporary change in the Fed's inflation goal with additional stimulus. Fiscal stimulus would probably be the most effective option but, if unavailable, the Fed could combine any promise to boost inflation with additional balance sheet expansion. Second, a commitment to raise inflation to boost the economy is most desirable during times when the economy is weak and inflation is below the Fed's target (as was the case when President Roosevelt took office). Otherwise, the Fed would need to trade off the costs of above-target inflation with more growth. The likelihood that the Fed would adopt an "unconventional" unconventional policy would thus rise sharply should deflationary concerns re-emerge going forward.


Which contracts interestingly with the insights of the following article, particularly the author's perspective on the Fed's raison d'etre (for the benefit of the banking class) versus its capability to print, advocating a slow-and-steady 'controlled deflation':


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redpill's picture

When the only tool is a hammer...

Cynical Sidney's picture

unconventional policy/deflation endgame == WWII, which ended the great depression.

What these cluebags are really saying, is that we need revolutions and another world war to end current crises. if that's the case i sincerely wish that these white collar criminals and financial gluttons are the first to be purged in the upcoming war/revolution

DormRoom's picture

The Fed must not implement a policy of higher inflation!  Firstly, Goldman Sachs assumes a large fiscal stimulus coupled with Fed action.  But fiscal stimulus by means of direct government jobs, which has the largest multiplier effect, has a slim chance, due to the Tea Party.  So without proper fiscal stimulus, increasing inflation expection, implies further misallocation of capital, likely into commodities, which will lead to HUGE adjustments in the medium term, ie a great depression or US sovereign default.


Furthermore, increased inflation expectation, but a fiscal stimulus, that produces < 1 mutliplier effect, also leads to the same result.


Therefore the Fed must not act unless it is certain proper fiscal stimulus is applied before hand, or concurrently.

i_fly_me's picture

WWII did not end The Great Depression; WWII delayed recovery. It was only after the war ended, once the restrictions, price controls and, rationing were removed, that growth returned.

Sean7k's picture

I hate to spoil the ending, but you have to read to the ending. If you read the conclusion of the Austrian article, you will see exactly what the FED is doing and will continue to do in the future. If you just read the conclusion, you will not understand it, but you will see the path chosen by Bernanke and the Banking Class.


mcguire's picture

the austrian article is one of the best articles i have read...  bravo!! 

yet, one aspect of his analysis that falls woefully short is that he does not consider the international nature and aspirations of the banking class..  

i wonder what he thinks of 'the bancor'..

if a monopoly on money in one country is good, then a monopoly on money in the entire globe would be better..

we all see the competitive devaluations, taking turns, around the globe.. it would be logical (albeit naive) to think that this in terms of central bank 'game theory' where the idea for each country is to gain trade advantages over the next..  but if we are going to talk about a 'banking class', it is more consistent to think that what is happening is a coordinated global attack on all currency regimes, getting ready to achieve that global monopoly that has been sought after since language was confounded at babel.. 

and of course, if you look outside of the economic sphere, there is more than enough evidence to corroborate aspirations for a "new world order", which would of course be the marriage of the political and banking class..

global hyperinflation is the price that will be paid to bring in the 'new monopoly'.... ordo ab chao... 


covert's picture

deflation is always the best policy and consequently, the least popular.


Dasa Slooofoot's picture

Do we get to flatten the #2 & #3 economies too? 

UP Forester's picture

They lost me at "unconventional" unconventional options.

Oh, yeah, its Newspeak,  er,  um,  Fedspeak.

Whiskey Tango Foxtrot, over.

MrSteve's picture

To best avoid confusing double-talk, read Charles P. Kindleberger. His Manias, Panics, etc is in every public library and can be read for free. Order up a copy today and get smart. He makes it all crystal clear.

Manias, Panics, and Crashes: A History of Financial Crises 

Fips_OnTheSpot's picture

Ok, so they have this ubersekret box including verrrry unconventional tools.

When do we see it? Christmas would fit - all the presents for a rallye (to nowhere).


This, my dear Sir, is a dead parrot!

philipat's picture

It's actually pining for the fyords where they don't use the Euro?

Thomas's picture

Is it just me or is anybody else suffering vomit fatigue? I find it harder and harder each day to read this stuff without getting physically agitated.

Spitzer's picture

This article is referring to Austrian deflation but Austrian deflation is only possible when currency is at least partially backed by gold under a gold standard.In case the author is not aware, the US is not on a gold standard.

There is a big difference.

Re-Discovery's picture

I am sorry, I usually appreciate your posts, but did you read the article?  The author very clearly explains the evolution -- or more appropriately devolution -- from the gold standard into the no standard.  In fact, this shift is the whole argument why we will face deflation, in his opinion.

In his view, in our current 'no standard' environment, our commercial banks have literally choked our system with debt.  As a result, the author expects that the system has no where to go but to start puking up that debt in the form of massive default and deflation.   The author believes that Fed action of increasing reserves in the system will not generate inflation because debt creation has already maxed out.  Fed has been a follower when it creates reserves for the banking system rather than a leader, as commercial banks have already stuffed debt into all the economy's channels without regard to the reserve requirements.

I think the 'inflation deflation' all comes down to whether you think the money creation mechanism in the banking system still works.  If it does, it seems inevitable that it will break down at some point.  The author is arguing that that point is now.

lookma's picture

The author is a moron poseur trying to pander to a crowd by using a label, "AE," instead of bothering to unerstand anything Mises wrote in lieu of a semanto-linguistic circle jerk.

Clearly what happens when the banking system fails is that the paper dollar grows ever stronger in purchasing power.  And the Fed is powerless because banks won't lend. 

WTF is that crap? Thanks for playing know run and get youself a snowcone.

lookma's picture

Some Mises:

No government is, however, powerful enough to abolish the gold standard. Gold is the money of international trade and of the supernational economic community of mankind. It cannot be affected by measures of governments whose sovereignty is limited to definite countries. As long as a country is not economically self-sufficient in the strict sense of the term, as long as there are still some loopholes left in the walls by which national governments try to isolate their countries from the rest of the world, gold is still used as money. It does not matter that governments confiscate the gold coins and bullion they can seize and punish those holding gold as felons. The language of bilateral clearing agreements by means of which governments are intent upon eliminating gold from international trade, avoids any reference to gold. But the turnovers performed on the ground of those agreements are calculated on gold prices. He who buys or sells on a foreign market calculates the advantages and disadvantages of such transactions in gold. In spite of the fact that a country has severed its local currency from any link with gold, its domestic structure of prices remains closely connected with gold and the gold prices of the world market.

Still confused?  How about this one (and no Johnny, that's not deflation we see when a huge credit expansion ends)

The wavelike movement affecting the economic system, the recurrence of periods of boom which are followed by periods of depression, is the unavoidable outcome of the attempts, repeated again and again, to lower the gross market rate of interest by means of credit expansion. There is no means of avoiding the final collapse of a boom brought about by credit expansion. The alternative is only whether the crisis should come sooner as the result of a voluntary abandonment of further credit expansion, or later as a final and total catastrophe of the currency system involved.

lookma's picture

Just to make it clear:


In theoretical investigation there is only one meaning that can rationally be attached to the expression inflation: an increase in the quantity of money (in the broader sense of the term, so as to include fiduciary media as well), that is not offset by a corresponding increase in the need for money (again in the broader sense of the term), so that a fall in the objective exchange value of money must occur. Again, deflation (or restriction, or contraction) signifies a diminution of the quantity of money (in the broader sense) which is not offset by a corresponding diminution of the demand for money (in the broader sense), so that an increase in the objective exchange value of money must occur. If we so define these concepts, it follows that either inflation or deflation is constantly going on, for a situation in which the objective exchange value of money did not alter could hardly ever exist for very long. The theoretical value of our definition is not in the least reduced by the fact that we are not able to measure the fluctuations in the objective exchange value of money, or even by the fact that we are not able to discern them at all except when they are large

tarsubil's picture

The second bolded line is so easy to forget. Forgetting that is the key to the deflationista's argument.

Pinto Currency's picture


Red Pill (above) and Spitzer -  you are right on.


The inflation (currency debasement) has already occurred over the past decades and the debt edifice is collapsing, worldwide.  The debt and currency bubble is unsustainable.


The deflation is only occurring when prices are measured in gold and silver.


How's the dollar doing?


Central banker and economics profession sophistry can find endless theories and proposed scenarios where debasing the buying power of currency just a bit more will benefit us when that is what has launched us off the rails in the first place.  Yakkity, yakkity.

DormRoom's picture

Austrian economics has been applied in the US under Hoover.  His Treasury secretary, Andrew Mellon, argued for the "leave it alone", or 'bleed out the excesses' economic approach ala Hayek.  And what happened?  The mother fucking depression. It wasn't until Keynesian intervention did the US economy slip out of the great depression.




Sean7k's picture

What part of Austrian economics includes a central bank? Or government expansion and the creation of cartels? Or fixed wages? Do you even know what Hoover did? The information is out there.

BigJim's picture

Or Smoot-Hawley? Or doubling income tax?

There seems an inexhaustible supply of Keynesian cannon-fodder out there, willing to fling themselves headlong onto the teeth of historical fact.

tarsubil's picture

I think you're thinking of 1920 when Harding didn't really do anything and the economy recovered quickly. Hoover's band of experts did stuff like raise taxes on the highest earners and well, you know this already, don't you?

BigJim's picture

O dear. Every few months we get one of these guys, spouting the same nonsense.

Yes, Mellon argued for 'leave it alone'. Did Hoover listen? No. He was thoroughly interventionist:

Read it and weep, ignoramus.

narnia's picture

Deflation has always been the market signal.  Trillions of $ of promises have been made on prices the free market cannot support. Absent another divergent mother of all bubbles coming along- which also would eventually pop- this debt has no where to go but destruction.  

What the author overlooks is the extent to which the Treasury is bound. This pocket- directly, through the FDIC, IMF, etc.- is the mother of all CDOs.  It is the owner/guarantor of all worthless government & post-paltry banking sector equity debts. Additionally, this pocket is also on the hook many more times over should interest rates rise to blow up the swap market.  

The Fed has to print to infinity to stay ahead of the destruction of the Treasury or to finance the destruction of the Treasury.  The posse is bearing down on the FRN & it truly has no where to go.

Sean7k's picture

Actually, the author is arguing that the deflation is being managed with controlled inflation, targeting the MBS overhang. This should remind readers of the shadow banking systemic collapse and the creation of easing to offset it. The consequences are high unemployment (which we can see) and and a static buisness environment of very low growth (Japan). 

This is being done to control popular passions and to maintain the structure that allows the banking class to maintain its' position in control of wealth transfer. 

Goldtoothchimp09's picture

this argument is an ongoing battle -- Geithner the weasel suggesting the Europeans leverage up -- and the Europeans calling the idea stupid.

The US won't be able to go it alone... seems clear they would go the inflation route.  Europe may not allow them.  The war of ideas is on currently.

newbee's picture

And they still think big brother can control the economy.  Good lord, let the free market do what it's best at, and get big gov out of the way!!

Bartanist's picture

Obviously they can't have that because they would be forced to collapse all of the major banks, individual stocks/companies would all fall to the value of their cash flows and those bucket shop bets they have been selling for the last 10 years would fall to a price of $0. Endus Ponzius.

This would a result in the global banking cabal losing all of their power... and they cannot allow that. It is fascism, martial law, global war and Governor Tarkin squeezing his greasy fingers around your throat first.

Gubbmint Cheese's picture

Reminds me of Rummy's classic, ' unknown unknowns' from the beginning of the Iraq war (part II).

philipat's picture

“There are known knowns. These are things we know that we know. There are known unknowns. That is to say, there are things that we know we don't know. But there are also unknown unknowns. These are things we don't know we don't know”


Come again? I think he had been taking too many of his own pharmaceuticals?

N57Mike's picture

I always liked .... "the Syrians are being noticeably unhelpful"

jeff montanye's picture

not at all.  for a hard core war criminal rummy sometimes offered insight.  an unknown unknown?  the cause of disease prior to the understanding of pathogens when doctors argued about which humor (choleric, melancholic, sanguinary, phlegmatic) dominated the patient and bled her.  the doctors knew they weren't sure which humor was excessive or exactly how much to bleed her, but didn't know they didn't know anything about what was really happening.

for some reason i am reminded of the report of the 9-11 commission (or more exactly of the credulous readers of same).

geekgrrl's picture

WTF is "unconventional" unconventional policy?

These bankers have the most convoluted explanations imaginable. How does jacking up inflation solve a debt problem? It reminds me of what my mother always used to say: You can dazzle them with brilliance, or you can baffle them with bullshit. I think I know which we're seeing here.

itchy166's picture

Unconventional unconventional policies are somewhat more conventional than unconventional unconventional unconventional policies but are less conventional than conventional unconventional policies.  Do not confuse them with unconventional conventional unconventional policies which should only be used in conventional unconventional deflationary times.

I hope that helps.


geekgrrl's picture

Thanks for the comic relief itchy! That was the best laugh I've had in weeks! I'm just glad I read it tonight and not in the morning with coffee... :-)

Whalley World's picture

Did Goldman say that FDR's policies ended the depression.  Not from my research

Johnk's picture

As Spitzer points out, there are no brakes on this train. 

What do the last, oh, say 2500 years of human history tell you?  If they can print/debase, they will, and they can. 

Every conceivable endgame (except for an asteroid hitting the Earth) results in your cost of living being markedly higher in the future.  Deflationists can argue semantics and theory over reality all day long - in the end our purchasing power is declining.  It's the natural order.

philipat's picture

"CPI does not include volatile food and energy prices because...................................................................."

Answers please on a postcard to Mr B. Bernanke, Washington DC.

akak's picture

" .... because manipulating the government's CPI figures downward to pretend that the debasement of the US dollar is at all times less of a problem than it really is for the average citizen is tradition."

UP Forester's picture

".....because if we told you the truth, you might want to tar & feather, draw & quarter, mob & lynch or boil us in oil, thus reducing the value of the $10,000 suits and $2 ties that our bonuses from the value of the money we have stolen from you have paid for.  Thus we decree that you can't handle the truth."

Poor Grogman's picture

This is just a trial balloon, same one as Volker was talking about a week or so ago. The head morons are just trying to raise inflation expectations to get everyone borrowing money again.

This is all they have....

Global market horse-wisperers. Truly pathetic...

DalaiLamaInAShark's picture

I know there aren't many Krugman fans here, but I happen to believe that he's the best Keynes-o-meter available.  Interestingly, he's also been in support of higher inflation targets.

Yes, that's from back in May!

And, this one from July...

So, not all Keynesians are predicting higher inflation.  Krugman at least has been calling for a HIGHER inflation target as well.

Just an FYI.

Poor Grogman's picture

You are correct about one thing. There are not many Krugman fans here

DalaiLamaInAShark's picture

If there's one thing this on-going crisis should have proved to us is that modern economic theories (ALL OF THEM) are severely deficient.  I just try to stay abreast of what all the different camps are prediciting.  I've found that to be "prudent".  I'm just passing along some observations.

Cliff Claven Cheers's picture

Thanks for the insights. I think you are very well served to stay abreast of all the camps.