Narayana Kocherlakota of the Pain Caucus, President of the Minneapolis Fed, wrote that the Federal Reserve must raise interest rates before too long a time has passed or else its low interest rate policy will generate deflation:
Narayana Kocherlakota Speech: But over the long run, money is, as we economists like to say, neutral.... [I]f the FOMC maintains the fed funds rate at its current level of 0-25 basis points for too long, both anticipated and actual inflation have to become negative. Why? It’s simple arithmetic. Let’s say that the real rate of return on safe investments is 1 percent and we need to add an amount of anticipated inflation that will result in a fed funds rate of 0.25 percent. The only way to get that is to add a negative number—in this case, –0.75 percent... a low fed funds rate must lead to consistent—but low—levels of deflation.... If the FOMC hews too closely to conventional thinking, it might be inclined to keep its target rate low. That kind of reaction would simply re-enforce the deflationary expectations and lead to many years of deflation...
People--most notably Nick Rowe--correctly took exception.
As Andrew Harless put it: Kocherlakota said that if you want it to be dry then people should not carry umbrellas because umbrellas cause rain, while the correct statement is that if it is going to be dry then people will not carry umbrellas.
Now comes Stephen Williamson, claiming that all Kocherlakota said was that deflation would be a period of low interest rates:
Stephen Williamson: New Monetarist Economics: More-Than-Ever Worked Up About Nothing: I missed some of this stuff, as I try not to read DeLong's blog, for fear of depreciating my human capital. Here's a Krugman post, and a LeDong post relating to this. Having a rational discussion with these guys is something like having afternoon tea with a couple of psychotic ferrets....
Ultimately, the lower monetary growth as the result of tightening leads to lower inflation and lower nominal interest rates over a longer horizon. Look at what happened after the Volcker tightening. Nominal interest rates went up, then they came back down again as the inflation rate fell. In the short run, there is a "liquidity effect" whereby tight monetary policy tends to increase the nominal interest rate. In the long run, what dominates is the "Fisher effect" whereby an inflation premium gets built into the nominal interest rate. That's pretty much what Krugman and DeLong seem to be trying to say. What's all the heat about?
Perhaps Williamson is genuinely too stupid to notice that Kocherlakota said "a low fed funds rate must lead to... deflation" when he should have said "a low fed funds rate reflects the existence of deflation..."
Perhaps Williamson knows very well that umbrellas do not cause rain, and that Kocherlakota said that umbrellas cause rain as an argument for higher interest rates soon, but that Williamson is just pretending not to understand what is going on.
In neither case is the spectacle edifying.