Must-read: Tim Duy: “Lacker, Kaplan, Fischer”

Must-Read: The list of features of the current macroeconomic situation that the Federal Reserve’s communications strategy suggests that it does not grasp keeps growing. In the past we had:

  • The asymmetry of the loss function for undershooting vis-a-vis overshooting nominal GDP growth.
  • The weakness of monetary policy tools as stimulus in and near the liquidity trap vis-a-vis the strength of monetary policy tools to cool off the economy always.
  • The extraordinarily low precision of estimates of the Phillips Curve.

And now we have also:

  • The degree to which the slope of the Phillips Curve now is smaller than it was in the 1970s.
  • The degree to which the gearing between increases in inflation now and increases in future expected inflation has decreased since the 1970s.
  • The fact that lack of strong association between financial jitters and subsequent reduced growth is a reduced form that factors in a stimulative monetary response in response to such jitters.
  • The strong links between credit-channel disruptions and reduced spending growth.

And, above all, the fact that in the Greenspan and Volcker eras a lack of concern for downside risks was excusable because demand could always be swiftly and substantially boosted in an afternoon via large interest-rate reductions. Not so in the Bernanke-Yellen era.

It thus seems more and more to me as though the Federal Reserve is making macroeconomic policy in a world that simply does not exist. Tim Duy has comments:

Tim Duy: Lacker, Kaplan, Fischer: “Today Richmond Federal Reserve President Jeffrey Lacker argued that the case for rate hikes remains intact…

…On the opposite side of the table sits Dallas Federal Reserve President Robert Kaplan… very dovish…. Pure wait-and-see, risk management mode…. Federal Reserve Vice Chair Stanley Fischer remains less-moved by recent developments. Instead, low unemployment rates capture his attention…. Fischer sounds very uncomfortable with the prospect of the unemployment rate falling much below 4.7%. He is getting an itchy trigger finger.

I remain unmoved by this logic….

We have seen similar periods of volatility in recent years–including in the second half of 2011–that have left little visible imprint on the economy…. As Chair Yellen said in her testimony to the Congress two weeks ago, while ‘global financial developments could produce a slowing in the economy, I think we want to be careful not to jump to a premature conclusion about what is in store for the U.S. economy.’

This echoes the comments of… John Williams, and again misses the Fed’s response to financial turmoil. In 2011, it was Operation Twist…. I really do not understand how Fed officials can continue to dismiss market turmoil using comparisons to past episodes when those episodes triggered a monetary policy response. They don’t quite seem to understand the endogeneity in the system.

My sense is that there remains a nontrivial contingent within the Fed that really, truly believes they need to hike sooner than later for fear that overshooting the employment mandate will result in overshooting the inflation target. This contingent is attempting to look at the financial system as separate from the ‘real’ economy. That will not work. No matter how good the underlying fundamentals, if you let the financial system implode, it will take the economy down with it. I don’t know that the Fed needs to cut rates, or that they needed to cut rates as deeply as they did during the Asian Financial crisis, but I do know this: The monetary authority should not tighten into financial turmoil. Wait until you are out of the woods. That’s Central Banking 101…

February 25, 2016


Brad DeLong
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