"My model can identify the edge of a bottomless ZLB cliff. To the north of the edge of that cliff, there can be an equilibrium rate of inflation. To the south of the edge of that cliff, there cannot be an equilibrium rate of inflation, because the cliff is bottomless. Therefore inflation will not go south of that edge. We will never observe a truck going south over the edge of a bottomless cliff, because that can't be an equilibrium, since it is bottomless."
That's not good enough, but it's the best I can do. That is my reaction on reading Steve Williamson's post.
I have no (obvious major) problems with Steve's formal model. It is in Steve's interpretation of that formal model where I have a very big problem. If Steve had said 'This model shows that the central bank should not target a rate of inflation south of XYZ, because if it did so the inflation rate would fall over the edge of a bottomless cliff' I would be OK with it. But instead Steve is saying 'This model shows why inflation will not in fact go south of XYZ, because there is no equilibrium inflation rate over the edge of a bottomless cliff'.
This is not an isolated example. This is very much the same problem I have had with some of the things Narayana Kocherlakota has said. Something somewhere went very deeply wrong with the way macroeconomics is done in some places. I do not know why it went wrong like that.
This is not about politics or ideology. Explaining everything in terms of politics or ideology is one of those witchcraft explanations that only ignorant people use, who practice witchcraft themselves, and so think everyone else is a witch. I am pretty sure I am more right-wing than Steve is. This is about how we do economics.
This is not about sticky or flexible prices either. With sticky prices, the truck would fall slowly if it went over the edge of the cliff. With perfectly flexible prices it would fall instantly if it went over the edge of the cliff. But it could still fall over the edge of the cliff, regardless of whether prices are sticky or flexible (unless prices were completely stuck, of course, because then the truck can't move at all).
And it's not about who is more intelligent either. Steve probably is.
I despair of my ability to explain to Steve why I think his post is so horribly wrong. Why can't he just see it! It's obvious to my eyes. It's staring me straight in the face! All I can do is use useless metaphors about trucks not going over the edges of bottomless cliffs because the cliffs are bottomless.
Maybe I could suggest a minor change in his model. "Let's suppose there is a bottom to the cliff, because, oh, I don't know, the $20 note in my wallet would be worth more than the present value of the world's GDP, so I would buy the whole world, and live happily ever after, or something like that, so there is an equilibrium somewhere deep down there after all, so the truck can go over the edge of the cliff."
But that would be a total cop-out. His formal model is OK as is. It's telling us something interesting about the relationship between liquidity premia, time preference, and the location of the ZLB. It's his interpretation of that model that is so horribly wrong. It is not an explanation of why inflation did not in fact fall more than it did. How come he can't see it? How come there will be loads of other economists who won't see it either?
This is not just some random mistake on Steve's part. We all make those, and we can normally see them when other people point them out to us. This is not random; Steve is not alone; and I'm pretty sure he won't see it, and will just be bemused by this post.
What the hell has gone wrong with some of the best and brightest in economics? Is it too much math and not enough economics, so they are flying blind, reading the instruments, but have no idea what those instruments mean? Would it help to force them to say it in words? Or if they drew it in supply and demand curves, they would see that something is wrong. But we need math too, sometimes, because some things are hard to say clearly in words, or pictures. I despair.
Why didn't inflation fall further than it did when economies hit the ZLB? I don't know. Paul Krugman's explanation is that firms and workers don't like nominal wage cuts. Inflation fell over the edge of the cliff, but the cliff wasn't very deep at all. I think Paul's explanation is unsatisfactory and probably wrong. But it is an explanation. Steve's explanation isn't an explanation.
Update: there was significant deflation in the 1930's. It is not impossible.