Must-Read: Narayana Kocherlakota has been on quite a roll recently:

Narayana Kocherlakota: What We’ve Learned About Unconventional Monetary Policy: “Lesson 1: Even over relatively long periods of time…

…unconventional monetary policy tools don’t have extreme downside risks…. Lesson 2: Central banks are able to guide inflation close to its desired level using unconventional tools…. One could certainly ask: why was the FOMC consistently aiming for such a low inflation rate in this time frame, given that they expected such a high unemployment rate? (I have posed that question here.) But let’s leave that question aside. Throughout much of the 2008-10 period, many observers outside of the Fed expressed strong concerns about the risk of unduly high or unduly low inflation. Given that level of background uncertainty, I would say that the FOMC did a very good job at using unconventional tools to achieve what policymakers wanted in terms of inflation outcomes. Lesson 3: Hitting inflation objectives does not translate into hitting growth objectives…


Narayana Kocherlakota: Interest Rate Increases Are Hard to Undo?: “Yellen made the following statement…

I do not expect that the FOMC [Federal Open Market Committee] is going to be soon in the situation where it is necessary to cut rates….

I argue that her statement suggests that the FOMC’s policy moves will be inappropriately insensitive to adverse information about the evolution of the economy…. There’s some set of economic conditions for which a range of a quarter to half a percent for the target range for the fed funds rate is appropriate. Under an appropriately data-sensitive approach… the FOMC should slightly lower the fed funds rate target range if it confronts a slightly worse set of economic conditions [than that]…. If a move of zero is highly likely, surely a downward move of a quarter percent point should be more than a little possible? But Chair Yellen’s statement suggests that this isn’t the way that the FOMC is thinking about the situation…. She seems to be saying that it will take a pretty bad turn of events for the FOMC to be willing to reverse its December move.  Such an approach means that the FOMC’s December has created a new higher floor….

The FOMC could be a lot more data-sensitive than I’ve described when it considers interest rate cuts. Failing that, the other response is to realize that any future rate increase will push upwards on the new soft floor.  That realization should make the FOMC very cautious about undertaking any future rate increase.


Narayana Kocherlakota: Negative Rates: A Gigantic Fiscal Policy Failure: “Since October 2015, I’ve argued that the Federal Open Market Committee (FOMC)…

…should reduce the target range for the fed funds rate below zero. Such a move would be appropriate for three reasons:

  • It would facilitate a more rapid return of inflation to target.
  • It would help reduce labor market slack more rapidly.
  • It would slow and hopefully reverse the ongoing and dangerous slide in inflation expectations. 

So, going negative is daring but appropriate monetary policy. But it is a sign of a terrible policy failure by fiscal policymakers.

The reason that the FOMC has to go negative is because the natural real rate of interest r* (defined to be the real interest rate consistent with the FOMC’s mandated inflation and employment goals) is so low.   The low natural real interest rate is a signal that households and businesses around the world desperately want to buy and hold debt issued by the US government. (Yes, there is already a lot of that debt out there – but its high price is a clear signal that still more should be issued.)  The US government should be issuing that debt that the public wants so desperately and using the proceeds to undertake investments of social value.

But maybe there are no such investments?  That’s a tough argument to sustain quantitatively.  The current market real interest rate – which I would argue is actually above the natural real rate r* – is about 1% out to thirty years.  This low natural real rate represents an incredible opportunity for the US. We can afford to do more to ensure that all of our cities have safe water for our children to drink.  We can afford to do more to ensure that our nuclear power plants won’t spring leaks.  We can afford to do more to ensure that our bridges won’t collapse under commuters.

These opportunities barely scratch the surface.  With a 30-year r* below 1%, our government can afford to make progress on a myriad of social problems.  It is choosing not to. 

If the government issued more debt and undertook these opportunities, it would push up r*.  That would make life easier for monetary policymakers, because they could achieve their mandated objectives with higher nominal interest rates. But, more importantly, the change in fiscal policy would make life a lot better for all of us. 

I don’t think that Chair Yellen will say the above in her Humphrey-Hawkins testimony tomorrow – but I also think that it would be great if she did.

Narayana Kocherlakota: Dovish Actions Require Dovish Talk (To Be Effective): “The Federal Open Market Committee (FOMC) has bought a lot of assets and kept interest rates extraordinarily low…

…Yet all of this stimulus has accomplished surprisingly little (for example, inflation and inflation expectations remain below target and are expected to do so for years to come)…. Over the past seven years, the FOMC’s has consistently talked hawkish while acting dovish. This communications approach has weakened the effectiveness of policy choices, probably in a significant way…. In December 2008, the FOMC lowered the fed funds rate target range to 0 to a quarter percent. It did not raise the target range until December 2015, when the unemployment rate had fallen back down to 5%.   But – with the benefit of hindsight – a shocking amount of this eight years’ worth of unprecedented stimulus was wasted, because it was largely unanticipated by financial markets…