Fortunately, creating inflation is not rocket science. All central banks need to do is to keep printing money to buy up government debt. The main risk is that inflation could overshoot, landing at 20% or 30% instead of 5-6%. Indeed, fear of overshooting paralysed the Bank of Japan for a decade. But this problem is easily negotiated. With good communication policy, inflation expectations can be contained, and inflation can be brought down as quickly as necessary.It's sad that such an influential economist as Rogoff doesn't know the true lesson of the Bank of Japan. They were not paralyzed by overshooting but undershooting that the inflation didn't occur in spite of their "quantitative easing" with which they put 35 trillion yen ($ 380 billion) to bank's accounts in the BoJ. Because, as Rogoff apparently knows, monetary aggregate isn't controllable by central banks that supplies the monetary base. The former is an endogenous variable determined by money demands of private sectors.
Especially when the economy suffers from deflation, the natural rate of interest is less than zero, so the real interest rate (nominal rate plus deflation rate) will be higher than the natural rate because nominal rate can't be negative. When the real interest rate is higher than the natural rate, deflation will occur, as Wicksell predicted a hundred years ago. Paul Krugman wrote ten years ago:
A liquidity trap may be defined as a situation in which conventional monetary policies have become impotent, because nominal interest rates are at or near zero - so that injecting monetary base into the economy has no effect, because monetary base and bonds are viewed by the private sector as perfect substitutes.Japan experienced exactly as he predicted: while the BoJ dropped the interest rate to zero and supplied huge amount of monetary base, the monetary aggregate didn't increase because money demand was very weak. So Krugman was right when he wrote:
If the central bank can credibly commit itself to pursue inflation where possible, and ratify inflation when it comes, it should be able to increase inflationary expectations despite the absence of any direct traction on the economy via current monetary policy.However, it's difficult for the BoJ to commit making inflation when they are impotent to increase monetary aggregate. Krugman recommended the BoJ to be irresponsible to seek a higher future price level. Unfortunately this policy isn't subgame perfect, using the term of game theory. In the subgame after inflation occurs, the BoJ will abandon the inflation policy. As rational players know it, they won't make the forward-looking expectation of inflation. So the subgame perfect equilibrium is no inflation at all.
These are elementary theories supported by the painful experience of Japan. For example, Hiroshi Ugai of the BoJ wrote a survey article of many empirical findings. He concludes:
Granted the positive above effects of preventing further deterioration of the economy reviewed above, many of the macroeconomic analyses conclude that the Qunantitative Easing Policy's effects in raising aggregate demand and prices were limited. In particular, when verified empirically taking into account the fact that the monetary policy regime changed under the zero bound constraint of interest rates, the effects from increasing the monetary base were not detected or smaller, if anything, than during periods when there was no zero bound constraint.Indeed, Prof. Rogoff, creating inflation is not rocket science. It's much more difficult to create inflation when deflation is going on than launching rockets.
