Blanchard on expectations

Matt loves to talk about multiple equilibria and how changing expectations can shift us between Pareto-ranked equilibria. It turns out he’s not the only one who thinks it’s an important matter in the current environment. Here is Olivier Blanchard discussing recent developments in the implementation of monetary policy.

In a world of multiple equilibria, announcements can matter a lot. Take for example the case of the Outright Monetary Transaction program announced by the European Central Bank.  …The announcement has succeeded, without the program actually having to be used.

From this viewpoint, the recent announcement by the Bank of Japan that it intends to double the monetary base is even more interesting. What effect it will have on inflation depends very much on how Japanese households and firms change their inflation expectations. If they revise them up, this will affect their wage and price decisions, and lead to higher inflation—which is the desired outcome in the Japanese deflation context.  But if they do not revise them, there is no reason to think that inflation will increase much.

This very much reinforces the message of people like Woodford and Sumner that the expectations channel is by far the most important one for monetary policy.