So the core CPI — consumer prices excluding food and energy — fell for the first time since 1982. But that could be just a blip. Also, core CPI has been behaving erratically lately, making me doubt whether it’s still a good guide to underlying inflation (by which I mean the trend in prices that, unlike commodity prices, have a lot of inertia).

What I find myself looking at these days are the Cleveland Fed “trimmed” inflation measures, which exclude outlying large price movements; the ultimate trim is the median, the rise in the price of the median category. And these indicators tell a story of dramatic disinflation in the face of a week economy:

Federal Reserve Bank of Cleveland

I find this a scary picture. For one thing, it suggests that deflation may not be too far in the future. But beyond that, there’s a growing belief among sensible economists that we need higher, not lower inflation. What we’re doing now is moving in the wrong direction, with real interest rates rising even as the nominal rate remains at zero.

We may have to start calling the Fed chairman Bernanke-san, after all.

So I’ve seen the economists’ letter opposing premature fiscal tightening in Britain, and hear it will be published tomorrow. I fully agree with the writers’ position.

The crucial thing to understand is that fiscal contraction of an additional one or two percent of GDP in the near future has essentially no significance for the sustainability of government finances, either in Britain or here. The only reason to do it is to impress markets — to convince them of your willingness to bear pain. And absent structural reform — which is the real need — how much good does that do?

So let’s not impose useless punishment, there or here.

Hear, hear.

The only point Wolf doesn’t really emphasize is the extent to which the deficit hysterics are also deficit peacocks. They’re full of bombast, and eager to shoot down anything that might reduce unemployment. But when it comes to serious proposals to bring the long-run fiscal outlook under control — which means, above all, doing something about health care costs — all we get is the sound of crickets chirping.

Today, Martin Feldstein suggests that Greece make a temporary return to the drachma, so as to regain cost competitiveness. In terms of the macroeconomics, this actually does make sense. But it’s also impossible; Feldstein needs to read Barry Eichengreen. Here’s Eichengreen on euro exit:

The insurmountable obstacle to exit is neither economic nor political, then, but procedural. Reintroducing the national currency would require essentially all contracts – including those governing wages, bank deposits, bonds, mortgages, taxes, and most everything else – to be redenominated in the domestic currency. The legislature could pass a law requiring banks, firms, households and governments to redenominate their contracts in this manner. But in a democracy this decision would have to be preceded by very extensive discussion.
And for it to be executed smoothly, it would have to be accompanied by detailed planning. Computers will have to be reprogrammed. Vending machines will have to be modified. Payment machines will have to be serviced to prevent motorists from being trapped in subterranean parking garages. Notes and coins will have to be positioned around the country. One need only recall the extensive planning that preceded the introduction of the physical euro.

Back then, however, there was little reason to expect changes in exchange rates during the run-up and hence little incentive for currency speculation … In contrast, if a participating member state now decided to leave the euro area …the very motivation for leaving would be to change the parity.

Market participants would be aware of this fact. Households and firms anticipating that domestic deposits would be redenominated into the lira, which would then lose value against the euro, would shift their deposits to other euro-area banks. A system-wide bank run would follow. Investors anticipating that their claims on the Italian government would be redenominated into lira would shift into claims on other euro-area governments, leading to a bond-market crisis. If the precipitating factor was parliamentary debate over abandoning the lira, it would be unlikely that the ECB would provide extensive lender-of-last-resort support. And if the government was already in a weak fiscal position, it would not be able to borrow to bail out the banks and buy back its debt. This would be the mother of all financial crises.

How is it that I never knew about this? It turns out that in the 19th century, Republicans believed in the Laffer curve, just as they do today — except that they used it as an argument to raise taxes, to get rid of an unwanted surplus. Seriously. Here’s Doug Irwin:

After the Civil War, Congress justified high import tariffs (relative to their prewar levels)” as necessary in order to raise sufficient revenue to pay off the public debt. By the early 1880s the federal government was running large and seemingly intractable fiscal surpluses: revenues exceeded expenditures (including debt service and repurchases) by over 40 percent during that decade. The political parties proposed alternative plans to deal with the surplus: the Democrats proposed a tariff reduction to reduce customs revenue, the Republicans offered higher tariffs to reduce imports and customs revenue. This paper examines this debate and attempts to determine the revenue effects of the proposed tariff changes. The results indicate that the tariff and the price elasticity of U.S. import demand during the 1880s below the maximum revenue rate, and therefore a tariff reduction would have reduced customs” revenue.

So Vitor Constancio is going to be the next vice president of the ECB. Hey, I know that guy!

Back in 1976 there was a small mission of MIT grad students working at the Bank of Portugal; I’ve said a bit about that here and here. Constancio was one of the people we worked with.

I have no insight into his current views, although the word is that he’s an inflation dove — which of course is a position I approve of. But it’s good to see him doing so well, all these many years later.

Nineteenth-century trade policy, here. (pdf)

Some readers have requested videotaped lectures. Not this semester, I’m afraid; it’s a seminar-style class, and I think it would be way too intrusive. Some other time.

At this point the odds are that in response to the most devastating financial crisis since the Great Depression, we will do … nothing.

And while there is plenty of blame to spread around, it’s important not to be too even-handed. The fact is that the Democrat-controlled House has already passed a pretty good reform bill. But in the Senate, well, here’s what the FT reports:

Senate Republicans are resisting a fundamental tenet of the Obama administration’s financial regulatory reforms in another obstacle for the stalled legislative process.

Several aides from both parties involved in reform negotiations told the Financial Times that Republicans had opposed in private a plan to impose tougher capital and liquidity requirements on companies that posed a risk to the financial system.

That’s tantamount to opposing any real reform.

You might think that the GOP would pay a political price for this. But it already has its strategy: insist that black is white.

The right-wing group “Committee for Truth In Politics” seems to have taken the advice of the postmodernist Frank Luntz, and cast new regulations on Wall Street, which Wall Street is furiously attempting to kill, as a giant favor to Wall Street.

And they’ll probably get away with it.

There’s an economists’ duel underway in Britain. Everyone agrees that Britain needs to address its underlying budget deficit; but how fast? One group of prominent economists has published a letter saying that cuts should start more or less immediately.

But an equally or maybe even more prominent group disagrees, pointing out that slashing spending now would depress a still very weak economy. Their letter isn’t public yet; I’ll post a link when it is.

As you might guess, I’m very much in agreement with the second group. It’s important to be clear that the call for immediate austerity isn’t grounded in unarguable economics; in fact, the arithmetic tells you that what Britain does in the next year or two is virtually irrelevant to its long-run solvency. Instead, the call for immediate austerity is based on an appeal to “credibility”, which is very much in the eye of the beholder.

So for Britain’s sake, I hope that the UK version of 21st century Hooverism doesn’t prevail.

Reading the comments on today’s column, I was startled to find a number of commenters assuming that I have switched my position on the euro. Some cited this piece, while others assumed that my criticism of the euro was somehow inconsistent with the good things I’ve had to say about European social insurance.

Ahem. If you actually read the old piece, it’s an assertion that the United States shouldn’t fear the euro’s challenge to the dollar; it said nothing about the euro’s desirability for Europe. And I do believe it’s possible to admire French health care while not admiring Europe’s monetary arrangements.

Anyway, I’ve always been a mild euroskeptic — I’m one of the American economists that Jonung and Drea, in a spectacularly ill-timed piece, mock for their doubts about EMU. My concerns were always just what they are now: fears that the lack of fiscal and labor market integration would lead to very nasty adjustment problems. I just never dreamed how bad it would get.

Just the obvious point: whatever his real reason for suddenly dropping out — everyone is still wondering — by dropping out with no warning, leaving his own party unable to stage a proper primary, Bayh was behaving selfishly and irresponsibly.

Yet you can be sure that many of the usual suspects will treat him as some kind of principled paragon. After all, he denounced the nastiness of partisan politics — while doing his best to reward it.

Add: Ezra Klein:

Evan Bayh has decided to retire. He said he wants to spend more time scolding his family for moving too far to the left.

The political economy of trade policy, here.(pdf)

While looking at the Economic Report of the President, I was inspired to make this chart, which actually doesn’t come from the ERP (more ERP blogging in a day or two). It shows the contribution of the ARRA, aka the Obama stimulus, to the deficit — a rough measure of the amount of stimulus — with the CBO’s projection of the unemployment rate, by fiscal year:

Congressional Budget Office

Basically, the stimulus fades out fast starting in fiscal 2011, which starts in October 2010. Yet the consensus view is that unemployment will be around as high as it is now.

The point is that we’re doing a 1937 — or actually worse, since unemployment had in fact fallen dramatically before FDR made his big mistake. Fiscal support for the economy will be pulled away with the economy having barely begun to recover.

Olivier Blanchard, normally at MIT but currently the chief economist at the IMF, has released an interesting and important paper on how the crisis has changed, or should have changed, how we think about macroeconomic policy. The most surprising conclusion, presumably, is the idea that central banks have been setting their inflation targets too low:

Higher average inflation, and thus higher nominal interest rates to start with, would have made it possible to cut interest rates more, thereby probably reducing the drop in output and the deterioration of fiscal positions.

To be a bit more precise, I’m not that surprised that Olivier should think that; I am, however, somewhat surprised that the IMF is letting him say that under its auspices. In any case, I very much agree.

I would add, however, that there’s another case for a higher inflation rate — an argument made most forcefully by Akerlof, Dickens, and Perry (pdf). It goes like this: even in the long run, it’s really, really hard to cut nominal wages. Yet when you have very low inflation, getting relative wages right would require that a significant number of workers take wage cuts. So having a somewhat higher inflation rate would lead to lower unemployment, not just temporarily, but on a sustained basis.

Or to put it a bit differently, the long-run Phillips curve isn’t vertical at very low inflation rates.

I think this is especially important in the European context. As I’ve been writing in a number of posts, the period 2000-2008 saw a huge divergence in price levels between the capital-inflow nations of the European periphery and the European core. Here are deflators, 2000=100:

GDP DEFLATORS, 2000=100

IMF

Almost surely, that divergence now has to be reduced. Yet with a low overall inflation rate for the eurozone, that means large-scale deflation in the overvalued economies if convergence is to happen any time in, say, the next 5-10 years. (Actually, in Eurospeak I think this is cohesion rather than convergence, but never mind).

The task would be a lot easier if the eurozone had 4 percent inflation instead of 2.

So yes, let’s have modestly higher inflation. Alas, Ben Bernanke — at least when speaking publicly — doesn’t agree. And I can only imagine what Trichet would say.

Jonathan Chait, on the revelation that Paul Ryan is an Ayn Randite*:

Ryan clearly has a passion for ideas and isn’t just interested in short-term positioning. It would be nice if the party had people like that who didn’t also happen to be loons.

Ezra Klein on Leon Wieseltier:

Frankly, I find Wieseltier’s prose so self-admiringly opaque that it’s nearly impossible to figure out what he’s saying about anyone at anytime. It’s like being insulted in Sanskrit. It’s possible he’s writing something terrible, but who’s to say, really?

*But it’s topped by what the late Paul Samuelson said about Alan Greenspan:

You can take the boy out of the cult but you can’t take the cult out of the boy.