Category: Equitablog

Let me (surprise, surprise!) back up Paul here: There is no doubt that, technocratically, reflation is the low-hanging fruit to boosting equitable growth. Successfully returning to full employment would boost real GDP in the North Atlantic by 10% today, would boost future economic growth substantially as well, and would lift all economic classes more-or-less equally. No plausible policy shifts to produce “structural reform”–save possibly the “structural reform” of raising the price level in Germany and Holland relative to Italy and Spain by 20%–promises North Atlantic-wide benefits even a fifth as much.

But for many, once you start admitting that the Keynesian fiscal and Friedmanite monetary régime-change policies are the ones that pick the low-hanging fruit, you have put yourself in opposition to the German Ordoliberals and the British Conservatives and the American Republicans (all save James Pethokoukis, Scott Sumner, and Ramesh Ponnuru). And to say that the leftist fringe of European and British politics and the Elizabeth Warren wing of the Democratic Party in America are right and deserve support–well, that appears to disqualify you from being taken seriously as a sensible centrist, or even as a sensible moderate left-of-center establishment thinker these days. It makes you… shrill…

A couple of years ago the fact that Olivier Blanchard’s shop at the IMF and that Jan Hatzius’s shop at Goldman Sachs are willing to hoist signal flags 1 and 6 together and point out what the macroeconomic evidence and theory suggested would be good policies gave me hope then for rational policy. And right now Syriza begs for less pointless, destructive austerity, Larry Summers continues his long campaign (with some IMF help) for large-scale publicly-funded infrastructure investment, Christina Romer continues to argue for monetary régime change, and there are others–but we are many, many fewer than we should be. And for what? for Wales?…

There are two major taxes on the upper middle class in our future–the carbon tax and the tax on “Cadillac” health-care plans. But these tax are coming because they will not be levied on the upper-middle class but on entities classified as unworthy–coal and oil companies and health-insurers. They will just be passed through to the upper middle class.

So a lot rides over the next generation on the upper middle class’s remaining confused about tax incidence:

Must- and Shall-Reads:

• Robert Waldmann: Comment on “What Failed in 2008?”
• Paul Krugman: Europe’s Greek Test

1. Justin Wolfers @JustinWolfers on Twitter: What This Morning’s U.S. Wage Numbers Mean: “Employment cost index only up 0.6% in the past quarter, putting it up 2.2 percent over the year. Consistent with inflation well below 2%. If you think the US labor market is anywhere near capacity, you expect wages to be growing at 3.5-4%. They’re growing at 2.2%. There’s nothing in these wage data to give the Fed any confidence that inflation is going to drift back up towards its target anytime soon. The good news in these wage data is that this is the economy telling us that it can generate plenty more jobs without hitting bottlenecks. A thought on the Phillips Curve: Perhaps wage data are telling us that both the long-term unemployed & those out of the labor force matter.”

2. Aristotle: Slavery or Technology? From Politics: “Since then sufficient material resources are necessary for every household, the means of procuring them must certainly be part of household management, for without the material necessities it is impossible to live, let alone live well. All the arts share the property that the proper tools must be available if they are to be properly proper conducted. So is it in the art of managing a family. Now of tools, some of them are alive and others are not. With respect to the pilot of the ship, the tiller is not alive, the sailor is alive. In many arts the necessary tools include servants. Property in general is a tool for living. An estate is a collection of such tools. And a slave is a living tool. A tool that can take care of its own self is a more valuable one than any other tool. Suppose if every tool could, at command, or from discerning its owner’s desires, carry out its tasks (as the story goes of the automatons of Daedalus; or what the poet tells us of the serving-carts of Vulcan, ‘that they rolled of their own will into the gathering of the gods’), so that the shuttle would then weave and the lyre play of itself. Then the architect would not want living servants, or the owner want living slaves…”

3. Paul Krugman: Whitewashing the Crazy, Fed Edition: “How does one report on politics when a significant wing of the political spectrum is… stark raving mad?…. There’s a temptation to soft-pedal the crazy…. Matt O’Brien notes that Ted Cruz has now joined the ‘anti-Fed crazy train’…. [But] Alan Rappeport [of the New York Times who]… does… convey… how crazy Rick Perry was… uses a euphemism…. ‘Republicans have questioned the Fed’s moves to stimulate the economy since the financial crisis, arguing that the expansion of its balance sheet will create economic instability.’ Well, actually they have spent the past six years warning about ‘currency debasement and inflation‘. The chart shows how that prediction has turned out. And that in turn makes the fact that the anti-Fed ranks are swelling, not shrinking, a much more remarkable political story than the whitewashed version would indicate.”
   

4. Ricardo Hausmann: Redistribution or Inclusion?: “It is crucial to distinguish inequality in productivity among firms from unequal distribution of income within firms. The traditional battle between labor and capital has been about the latter…. But there is surprisingly deep inequality in firms’ productivity, which means that the size of the pie varies radically. This is especially true in developing countries…. These two very different sources of inequality are often conflated, which prevents clear thinking on either one…. Given productivity constraints, redistribution is only palliative, not curative. To address the problem requires investing in inclusion, endowing people with skills, and connecting them to the inputs and networks that can make them productive…”

Should Be Aware of:

• Reka Juhasz

1. Belle Waring: But Wait… There’s More!: “BIf someone would like to write an intelligent, detailed article about stifling political correctness in a specific online milieu of twitter users and feminist tumblrs, or whatever, WITH LINKS, they should do that, and then we can talk about that. But Chait didn’t write anything like that at all. There’s no reason I should extend him so much argumentative charity that I go bankrupt over here constructing his argument for him. It’s like trying to make an Eiffel Tower out of popsicle sticks in Pre-K, and my partner on the project uses each stick in turn like a nacho to eat paste off of, and then just hands them to me all slimy. I have better things to do.”

2. Saul DeGraw: Scam PACs Open Thread): “Kenneth Vogel reports on the rise of scam PACs and that they mainly exist in GOP circles. Kevin Drum wants to know why they exist more on the right-wing than the left. Any ideas?”

A generation or two ago, the push for central-bank independence was all about harnessing central banks’ credibility as inflation fighters in a context in which it was feared that elected legislators would lean overboard on the excessive spending side.

Today, Simon Wren-Lewis calls for transferring not just monetary policy but fiscal policy stabilization authority over to central banks, on the grounds that their technocratic chops are much better for fiscal policy then relying on elected legislators who are the prisoners of ordoliberal ideologies, the belief the governments like households need to balance their budgets, and of the austerity-loving 0.1%.

What could possibly go wrong?

…the year that the US, UK and Eurozone switched from fiscal stimulus to fiscal contraction… this policy switch is directly responsible for the weak recovery in all three countries/zones. A huge amount of resources have been needlessly wasted as a result, and much misery prolonged. This post is… about… taking that as given and asking what should we conclude…. To answer that question, what happened in Greece (in 2010, not two days ago) may be critical…. Let me paint a relatively optimistic picture of the recent past. Greece had to default because previous governments had been profligate and had hidden that fact from everyone…. Recessions… tend to be when things like that get exposed. If Greece had been a country with its own exchange rate, then it would have been a footnote… fiscal stimulus that had begun in all three countries/zones in 2009 would have continued (or at least not been reversed), and the recovery would have been robust. Instead Greece was part of the Eurozone…. Policy makers in other union countries prevaricated…. So the Greek crisis became a Eurozone periphery crisis…. This led to panic not just in the Eurozone but in all the advanced economies. Stimulus turned to austerity. By the time some in organisations like the IMF began to realise that this shift to austerity had been a mistake, it was too late. The recovery had been anemic.

Why is that an optimistic account? Because it is basically a story of bad luck…. Now for the pessimistic version. The political right in all three countries/zones was always set against fiscal stimulus…. Without Greece, we still would have had a Conservative led government taking power in the UK in 2010, and we still would have had Republicans blocking stimulus moves and then forcing fiscal austerity. The right’s strength in the media, together with the ‘commonsense’ idea that governments like individuals need to tighten their belts in bad times… [meant] austerity was bound to prevail…. Greece may have just voted against austerity, but there is every chance that in the UK the Conservatives will retain power this year on an austerity platform and the Republicans are just the presidency away from complete control in the US. If the pessimistic account is right, then it has important implications for macroeconomics. Although it may be true that fiscal stimulus is capable of assisting monetary policy when interest rates are at the ZLB, the political economy of the situation will mean it may well not happen….

When some economists over the last few years began to push the idea of helicopter money, I was initially rather sceptical… helicopter money when you have inflation targets is identical to tax cuts plus Quantitative Easing (QE), so why not just argue for an expansionary fiscal policy?… However, if the pessimistic account is correct, then arguing with politicians for better fiscal policy is quite likely to be a waste of time…. A more robust response is to argue for institutional changes so that politicians find it much more difficult to embark on austerity at the ZLB…. Central banks have QE, but helicopter money would be a much more effective instrument. To put it another way, central bank independence was all about taking macroeconomic stabilisation away from politicians, because politicians were not very good at it. The last five years have demonstrated how bad at it they can be…

Alan Rappaport of the New York Times here exemplifies the biggest problem with our current policy dialogue: when it is thought to be unfair to a current of thought to even report in plain language what they have been saying, we are all in big trouble:

Must- and Shall-Reads:

• Paul Krugman: Those Radical VSPs
• Avery Palmer: States with Weak Gun Laws and Higher Gun Ownership Lead Nation in Gun Deaths, New Data for 2013 Confirms
• Alan S. Blinder: Beware of Woolly-Minded Attacks on the Fed
• Joseph E. Stiglitz: Europe’s Lapse of Reason

1. Gernot Wagner: Climate Shock: It’s Not Over ‘Til the Fat Tail Zings: “Presenting his new book ‘Climate Shock’ co-authored with Martin Weitzman. If you had a 10 percent chance of having a fatal car accident, you’d take necessary precautions. If your finances had a 10 percent chance of suffering a severe loss, you’d re-evaluate your assets. So if we know the world is warming and there’s a 10 percent chance this might eventually lead to a catastrophe beyond anything we could imagine, why aren’t we doing more about climate change right now? We insure our lives against an uncertain future–why not our planet?…”

2. Jeet Heer: The New Republic’s Legacy on Race: From Du Bois to the Bell Curve: “Between the late ’30s and the mid-’70s, The New Republic was one of the best magazines outside the black press in its coverage of the rise of the civil rights movement. Thomas Sancton, Sr., managing editor from 1942–1943, was a particularly radical advocate, holding FDR’s feet to the fire for his compromises with the Jim Crow South, and doing brave reporting on the Detroit race riots of 1943…. [But when] the country’s conversation about race turned to more ambiguous debates over busing, affirmative action, and overcoming economic hurdles. The owner who would oversee that new era was Martin Peretz…”

3. Jaume Ventura: Capital in the 21st Century: “On 19th December, CEPR and the Bank of England hosted a joint workshop to discuss Thomas Piketty’s seminal work ‘Capital in the 21st Century’. Chaired by the Bank’s Chief Economist Andy Haldane, the panel comprised Orazio Attanasio, Tim Besley, Peter Lindert, Thomas Piketty and Jaume Ventura…”

4. Daniel Davies: Rules for Contrarians: 1. Don’t whine. That is all: “I like to think that I know a little bit about contrarianism. So I’m disturbed to see that people who are making roughly infinity more money than me out of the practice aren’t sticking to the unwritten rules of the game…. The whole idea of contrarianism is that you’re… setting out to annoy people…. If annoying people is what you’re trying to do, then you can hardly complain when annoying people is what you actually do. If you start a fight, you can hardly be surprised that you’re in a fight. It’s the definition of passive-aggression and really quite unseemly, to set out to provoke people, and then when they react passionately and defensively, to criticise them for not holding to your standards of a calm and rational debate. If [Levitt and Dubner’s] Superfreakonomics wanted a calm and rational debate, this chapter would have been called something like: ‘Geoengineering: Issues in Relative Cost Estimation of SO2 Shielding’ [rather than ‘Global Cooling’], and the book would have sold about five copies….

5. As Safe as Houses: “According to… Oscar Jorda, Moritz Schularick and Alan Taylor, the traditional view that banks primarily lend to businesses is out of date. In 1900 only 30% of bank lending was to buy residential property; now that figure is around 60%…. The growth of mortgage lending has led to property bubbles and financial instability… rising levels of mortgage debt are a better predictor of financial crises than surges in other forms of lending… financial crunches caused by mortgage binges result in deeper recessions and slower recoveries than episodes caused by other forms of debt. If mortgage lending is so risky, why are bankers so keen on it? The answer lies partly in public subsidies for mortgages, which have boosted home-owner…”

Should Be Aware of:

• Daniel Davies (2012): The Christmas Sermon 2012–“On Not Believing In Canada”
• Mark Ames: Andrew Sullivan is not the Future of Journalism
• Steve M.: Kathleen Paker: The Republicans Forced Palin to Embarrass Herself

1. Jeet Heer: The New Republic’s Legacy on Race: From Du Bois to the Bell Curve: “The magazine’s myopia on racial issues was never more apparent than in Peretz’s and editor Andrew Sullivan’s decision in 1994 to excerpt The Bell Curve…. The book had not been peer-reviewed, nor were galleys sent to the relevant scientific journals… ‘swept forward by a strategy that provided book galleys to likely supporters while withholding them from likely critics.’… The magazine can be seen as not just reflecting the media’s diversity problem, but actively contributing to it. Because most of the critiques were political and philosophic in nature, many readers were left with the false impression that the book had some scientific validity. By the time devastating scientific reviews appeared… the book already enjoyed unmerited prestige, thanks to the imprimatur of The New Republic. The Bell Curve was perhaps the most impactful, and unfortunate, example of the magazine’s embrace of racial mythmaking…”

2. Peter Weinhart: Rape and Consolatio: “Augustine is the first to address rape victims with consolatio, and in so doing he turns consolation into social critique: [Melanie Webb] ‘his consolation cannot simply be an exhortation to rape-survivors to re-orient themselves within a society that regards them with shaming suspicion. It must also be an admonition to civil leaders to re-orient society toward rape-survivors as dignified women without requiring “proof” of innocence. Augustine initiates his project of social criticism through the genre of consolatio’…”

3. : The New Republic’s Legacy on Race: From Du Bois to the Bell Curve: “A 1995 piece by Ruth Shalit argued that if The Washington Post hired strictly on merit, it would be an all-white newspaper: ‘The Post, of course, is in an agonizing position. If editors refuse to adjust their traditional hiring standards, they will end up with a nearly all-white staff. But if they do reach out aggressively to ensure proportionate representation for each relevant minority, they transform not just the complexion but the content of the paper.’ Shalit’s piece made no mention of the fact that the magazine she was writing for had an almost all-white editorial staff. After the piece appeared, roughly half of the 28 Post staffers Shalit interviewed wrote in to say that she had either lied about what they told her or misrepresented them; The New Republic printed only a fraction of these complaints…. Likewise… Stephen Glass penned a 1996 piece about the Washington, D.C. taxi cab industry that seemed to cater to Peretz’s appetite for melodramas illustrating black cultural pathology…. One may also ask if a staff dominated by privileged white males might not have benefited from greater diversity, and not just along racial lines. ‘Marty [Peretz] doesn’t take women seriously for positions of responsibility,’ staff writer Henry Fairlie told Esquire magazine in 1985…”

4. Fredrik deBoer: I don’t know what to do, you guys: “You’ll forgive me when I roll my eyes at the army of media liberals, stuffed into their narrow enclaves, responding to Chait by insisting that there is no problem here and that anyone who says there is should be considered the enemy…. The culprits overwhelmingly were not women of color. That’s always how this conversation goes down: if you say, hey, we appear to have a real problem with how we talk to other people, we are losing potential allies left and right, then the response is always ‘stop lecturing women of color.’ But these codes aren’t enforced by women of color, in the overwhelming majority of the time. They’re enforced by the children of privilege. I know. I live here. I am on campus. I have been in the activist meetings and the lefty coffee houses…. I know I’ll get read the intersectionality riot act, even though everyone I’m criticizing here is white, educated, and privileged…. Christ, I wish people would think outside of their social circle for 5 minutes…. I want a left that can win, and there’s no way I can have that when the actually-existing left sheds potential allies at an impossible rate. But the prohibition against ever telling anyone to be friendlier and more forgiving is so powerful and calcified it’s a permanent feature of today’s progressivism. And I’m left as this sad old 33 year old teacher who no longer has the slightest f—ing idea what to say to the many brilliant, passionate young people whose only crime is not already being perfect…”

5. Michelle Goldberg: Jonathan Chait and the New PC: “Unlike some of Chait’s critics, I think there is such a thing as renascent political correctness…. But… he conflates several different things… genuine suppression of speech… annoying rhetorical tropes of online discourse… energetic debate…. Chait describes a torrent of online derision directed at his friend Hanna Rosin under the hashtag #RIPpatriarchy. In Chait’s version, the hashtag is a reaction to her book, The End of Men…. In fact, the hashtag was spurred by a related Slate piece with the trollish headline, ‘The Patriarchy is Dead: Feminists, accept it.’ The patriarchy not being dead, feminists did not accept it. That’s not stifling political correctness. It’s responding to speech with more speech…. ‘Her response since then has been to avoid committing a provocation, especially on Twitter,’ Chait writes of Rosin…. Social media has dramatically raised the psychic cost of voicing unpopular opinions…. To which, I suspect, many on Twitter would reply boo-fucking-hoo…. For Twitter’s guardians of righteousness, if privileged journalists feel more inhibited about bucking lefty pieties, so much the better…. Such a style, of course, was a hallmark of the Old New Republic… the magazine mistook common prejudice for unspoken truths…”

Hoisted from the Archives: The conventional Fisher-Friedman approach to the determination of nominal spending and income focuses on the equilibrium demand and supply of money through the quantity theory:

(1) PY = MV(i)

If the economy’s money-supply process has produced “too little” money for the current level of spending, businesses and households attempt to shift their portfolios and accumulate more money by (i) trying to sell some of their other financial assets for cash, and (ii) cutting back on their spending. Thus the flow of spending—and income, and production—falls until PY has fallen by enough to make households and businesses no longer seek to increase their money holdings. Combine this focus on money supply and money demand equilibrium with some model of price theory and price adjustment, and the result is a theory of the monetary business cycle.

At the zero-interest rate lower nominal bound, this Fisher-Friedman framework breaks down. With no opportunity cost to holding wealth in money rather than in other short-duration safe nominal assets, there is no reason for changes in the money stock to induce any changes in the flow of spending at all. Anybody seeking to model nominal and real income determination must then find another, alternative equilibrium condition to focus on.

The conventional theoretical macroeconomic step to take is to focus on the intertemporal Euler equation of a representative household with rational expectations: is it on an optimal consumption-savings path? But focusing on the Euler equation requires that there be (a) no disagreements between investors, and (b) a meaningful representative household, with (c ) correct rational expectations. If we are unwilling to make those assumptions, we are then driven back to the equilibrium condition from which, given the existence of no disagreements, a representative household, and rational expectations, the Euler equation was derived.

This equilibrium condition–appropriate for a more general theory—-is the Wicksell-Hicks flow-of-funds through financial markets condition: the supply of savings vehicles must be equal to the demand for savings vehicles. If the demand for savings vehicles is greater than the supply, people will cut back on spending their savings on currently-produced goods and services as they try to boost their holdings of savings vehicles. Spending, production, and incomes will fall until people feel so poor that they no longer wish to boost their holdings of savings vehicles. When the supply of savings vehicles is greater than demand, people will increase their spending as they try to turn their excess asset holdings into current consumption. Spending, production, and incomes will rise until the richer society is happy holding the existing supply of savings vehicles.

Thus theories about the effectiveness or ineffectiveness of any kind of policy—monetary, fiscal, banking, whatever—at the zero nominal interest rate lower bound are ways of deploying Wicksell-Hicks flow-of-funds equilibrium condition. They are theories about:

(2) B + S = B + I + (G – T)

about the demand for savings vehicles—the sum of the current stock of financial assets in the economy B and desired additions to that stock through savings S—and the supply of savings vehicles—the sum of the current supply of financial assets B plus business investment I plus government debt issuance G – T.

Note that if you wish to assume a (a) representative agent with (b) rational expectations you are still committed to an analysis via (2). It is a consequence of your intertemporal Euler equation. If and only if (2) holds, then your representative agent with rational expectations is on its optimal consumption-savings path.

Equation (2) gives us insight into the potential effectiveness of monetary policy at the zero lower bound. Such non-fiscal policies do not, by definition, change the supply of savings vehicles: they simply swap one savings vehicle in private portfolios for another—cash for Treasuries, short Treasuries for GSEs, private obligations subject to bankruptcy risk for private obligations backstopped by a government guarantee. For them to boost the economy therefore, they too must work via their effects on reducing private savings S or boosting private investment I.

How can they do this?

Mostly, they do this by convincing financiers that the path of real interest rates will be lower in the future than they had expected. Even though at the zero nominal lower bound the current size of the money stock is irrelevant because the opportunity cost of holding money is zero, this will not always be the case. Someday the size of the money stock will matter again. And if the central bank now takes steps that credibly promise such a larger money stock in the future when it matters, then expectations of lower nominal interest rates and higher price levels in the future which should boost investment and other real interest-sensitive components of spending now.

What are these policies?

Jawboning to reduce anticipated real interest rates: The central bank can claim that it will maintain interest rates in the future at a lower level and the money stock at a higher level than that of its normal policy reaction function. Thus, the central bank would claim, inflation will be higher in the future than forecasts based on normal reaction functions would allow. That means that real interest rates will be lower—and that would push down savings and push up investment.

The potential difficulty is that open-market operations can be unwound. That the Federal Reserve has raised the money stock this year does not necessarily mean that it will keep the money stock five years hence above the level called for by its standard reaction function. Pure jawboning is the ultimate in cheap talk. Jawboning backed by quantitative easing at the short end of the term structure is not quite pure cheap talk: the central bank is taking action. The problem is that the action is easily reversible.

Quantitative easing at the short end to reduce anticipated real interest rates: The central bank can claim that it will maintain interest rates in the future at a lower level and the money stock at a higher level than that of its normal policy reaction function—and back up those claims by expanding the money stock now by continuing to buy short-term government bonds for cash even though this is simply a swap of one zero-yielding short term safe nominal asset for another. The idea is that the Federal Reserve is not just claiming it will expand the money stock in the future—it has already expanded the money stock.

The potential difficulty is that open-market operations can be unwound. That the Federal Reserve has raised the money stock this year does not necessarily mean that it will keep the money stock five years hence above the level called for by its standard reaction function. Pure jawboning is the ultimate in cheap talk. Jawboning backed by quantitative easing at the short end of the term structure is not quite pure cheap talk: the central bank is taking action. The problem is that the action is easily reversible.

Quantitative easing at the long end to reduce anticipated real interest rates: The central bank can claim that it will maintain interest rates in the future at a lower level and the money stock at a higher level than that of its normal policy reaction function—and back up those claims by expanding the money stock now by to buying long-term government, agency, and private bonds for cash and committing to holding them to maturity. The idea is that the Federal Reserve is not just claiming it will expand the money stock in the future—it has already expanded the money stock. And such transactions are not or at least are not as easily unwound. Price pressure effects mean that the Federal Reserve will, embarrassingly, probably lose money on the round trip if it breaks its commitment to hold its purchased securities to maturity.

Quantitative easing at the long end may have another significant effect as well. By taking duration and, in the case of private bonds, default risk onto its balance sheet the Federal Reserve transfers that risk from the marginal investor to the marginal taxpayer. If the marginal taxpayer is at a corner solution in their financial market holdings or has a higher rate of time discount than the marginal investor or simply does not see through the government’s balance sheet, one consequence of quantitative easing at the long end is that investors will then have unused risk-bearing capacity. Duration and default risk spreads should then fall, and this fall in spreads should turn more investment projects into positive NPV ones. Quantitative easing at the long end thus has not only its potential principle effect on private investment and other forms of interest-sensitive spending via expectations of inflation and thus of real safe interest rates but also a secondary effect on investment via the government’s assumption of a role as a risk-bearing partner in private enterprise.

Back-of-the-envelope calculations based on standard finance principles suggest that this portfolio-composition effect should be insignificantly small. But similar arguments based on standard finance principles have long suggested that standard open-market operations in normal times should not be able to shake the intertemporal price system out for thirty years either, and there is a lot of evidence that standard open market operations in normal times do in fact have substantial effects.

Quantitative easing accompanied by declarations that the central bank has not changed its long-run inflation and price level targets: I do not understand why a central ban would pursue such a policy.

But that is the policy that the Federal Reserve appears to have decided to pursue.

Ryan Avent:

Monetary policy: The Fed’s communications problem: As I’ve written before, the commitment to allow higher inflation in the future is one of the key methods through which the central bank can have a positive effect on an economy stuck at the zero lower bound. The Fed’s efforts to clarify and push out the date at which it is likely to raise rates strikes me as a means to try and commit itself to higher inflation in the future. But the Fed’s communications efforts in this regard run up against a serious obstacle in the form of the Fed’s long-term inflation forecast, which is 2%. The Fed can’t force future central banks to keep to any policy path. If the Fed were to project a long-run inflation rate above 2% then, as Mr Bini Smaghi says, markets might suppose that monetary tightening lay ahead, whatever the fine print says.

This is not an unsolvable problem but is, I think, one of the tight spots in which the Fed finds itself as it transitions from a framework that wasn’t very good at boosting the economy at the ZLB to one that might be. One way to get around the problem would be to change the target, to 3% inflation or to something else, like a price or nominal GDP level, that implies future inflation above currently acceptable levels. The Fed may get there eventually, but probably not soon enough to have a meaningful impact on this recovery.

An alternative might be to bring the point at which future inflation is tolerated a bit closer to the present. That is, the Fed doesn’t necessarily run into problems of inconsistency if it projects inflation above 2% 1 or 2 years from now—a timeframe over which markets readily understand this group of policymakers to have control—while maintaining the long-run 2% goal. Achieving that would require the Fed to give itself a framework within which it’s acceptable to have inflation above 2% (and even to try to generate inflation above 2%), and as I wrote last week, I thought the Fed took a big step in that direction at its latest meeting. But one then has to choose to act within that framework. I suspect that what that will take is a near-term projection of inflation above 2% combined with action—asset purchases—designed to demonstrate that, yes, the Fed is actually trying to create a little catch-up inflation. At the last press conference, Ben Bernanke all but admitted that that would be a sensible thing to do. Now we just need to excise the “all but”.

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