Landings, Hard and Soft: Part 1

Brad DeLong has a nice wrap-up of recent postings on the subject from Mark Thoma, from William Polley, and from Brad Setser.  I've said much of what I have to say on the subject, but each of these posts raised some issue about which I feel compelled to comment. 

Mark comments:

Thus, in a hard landing, Krugman says "there will be no good options." But the Fed will need to do something. What should the Fed do in a hard landing?

Here, again, is a place where the conversation would benefit from a bit more precision in defining what we mean by "hard" and "soft."  If hard means "crisis," then we are talking about a situation with a very few reference points: October 1987, October 1998, September 2001.  There is absolutely no question about what a central bank does in such circumstances: It provides sufficient liquidity to stem the possibility of systemic meltdown in financial markets.  On this, I think both Brad DeLong and Mark Thoma agree (as suggested here and here, respectively).

That said, it is clear from Krugman's column that he  has a tamer definition of hard landing: "a combination of high inflation and high unemployment."  In these circumstances there may be few good choices, but there are certainly some bad options.  And they are likely to start with the presumption that we understand where "well short of full employment" (Krugman's words) might actually be. 

I would argue that the really big mistakes in the 1970s were associated with misdiagnosing a downward shift in the trend growth rate of productivity as a problem of deficient demand, and misguided attempts to fight temporary energy-price-induced declines in productive capacity with easy money.  As Mark has noted in several comments on this weblog, one of the most important macroeconomic lessons in the last several decades -- starting with Kydland and Prescott and working its way through Woodford -- is the notion that "potential GDP" is not the same thing as a straight line drawn through time.  In other words, "full employment" is lower following a oil shock than it is in less turbulent times.  As my boss says: 

In the long run, a central bank supplying more money cannot create more energy resources, but a credible monetary policy will help smooth economic adjustments that higher energy prices might require.

Indeed.

More to follow.