Nick Rowe asks: >Worthwhile Canadian Initiative: Re-learning the New Keynesian IS curve: [A]n empirical puzzle for New Keynesian macroeconomists. If macroeconomic black holes of deflationary spirals exist, and if bad monetary policy can cause economies to fall into one, why haven't we ever observed this happening? Does somebody up there like us? (At least, until now). Or is something wrong with the model? The Akerlof-Yellen answer--which I think is correct--is that the expectational Phillips Curve model of pricing is wrong. Cutting nominal wages substantially has such devastating effects on worker morale that employers simply do not do it in large numbers--even with enormous amounts of slack in the labor market. Thus the dynamic system has two basins that converge to two attractors: a basin that converges to "normal" with employment near full, the nominal interest rate equal to inflation plus the warranted natural real rate of interest, and inflation near the central bank's target; and a basin that converges to "Japan" with nominal interest rates at their floor and Deflation proceeding at its (slow) Speed limit. That, at least, is what you have to think the right model is, if you think Japan's experience over the past two decades has something to tell us about how the other North Atlantic economies work... And let me, to please Rajiv, reprint my draft comment on Bullard... ---- Extremely rough: A note on James Bullard (2010), "Seven Faces of 'The Peril'" ... Here is the graph: Bullard: >In this paper I discuss the possibility that the U.S. economy may become enmeshed in a Japanese-style, deflationary outcome within the next several years. To frame the discussion, I rely on an analysis that emphasizes two possible long-run outcomes (steady states) for the economy, one which is consistent with monetary policy as it has typically been implemented in the U.S. in recent years, and one which is consistent with the low nominal interest rate, dea?ationary regime observed in Japan during the same period.... When the line describing the Taylor-type policy rule crosses the Fisher relation [i.e., Wicksellian Balance], we say there is a steady state at which the policymaker no longer wishes to raise or lower the policy rate, and, simultaneously, the private sector expects the current rate of ina?ation to prevail in the future.... In the right-hand side of the Figure, short-term nominal interest rates are adjusted up and down in order to keep inflation low and stable. [Point A]... [A]s we move to the left... the two lines cross again, creating a second steady state [at Point B].... The policy rate cannot be lowered below zero, and there is no reason to increase the policy rate since well, inflation is already "too low." This logic seems to have kept Japan locked into the low nominal interest rate steady state. Benhabib, et al., sometimes call this the "unintended" steady state... Let's graph this, with the nominal interest rate on the vertical axis and the inflation rate on the horizontal axis... As I understand this model,...