Tag: Federal Reserve

Must-Read Pre-Liftoff Lollapalooza: Jared Bernstein: Will Inflation Really Snap Back Once “Temporary Factors” Abate?

Posted on by Brad DeLong

Must-Read Pre-Liftoff Lollapalooza: Even if there were no model uncertainty, the asymmetry of the situation would lead a rational optimizing policymaker to keep interest rates at zero until the need for liftoff was undeniable. With model uncertainty, a rational optimizing policymaker would keep interest rates at zero for considerably longer…

Jared Bernstein: Will Inflation Really Snap Back Once “Temporary Factors” Abate?: “I noted the Fed’s theory of the case as to why inflation isn’t accelerating…

…temporary factors, including low, low oil prices and the strong dollar, are blocking the usual signal…. [But] it’s not just that inflation isn’t picking up as output gaps close and unemployment falls. Inflation didn’t fall as much as expected when such activity gaps were much wider…. Blanchard, Cerutti, and Summers… a flat slope of the Phillips curve… ain’t exactly a new development…. The slope of the PC has been low for a decade… about 0.2, well below it’s historical levels in the 70s and 80s…. Larry Ball, in commenting on BCS, runs particularly transparent models and finds more stable, significant PC coefficients (though they are of the same magnitude as BCS)…. However, [he] do[es] not give much support to the view that the flat PC is temporarily low as a function of a few unique factors…. Inflation hawks, pull in your talons!

Must-Read Pre-Liftoff Lollapalooza: Jon Faust: Liftoff? And then…

Posted on by Brad DeLong

Must-Read Pre-Liftoff Lollapalooza: I find this from Jon Faust inadequate, mostly because if its failure to make even a bow in the direction of asymmetric risks. If the hawk scenario comes true, the Federal Reserve can then raise interest rates quickly to get to where it wants to be. If the dove scenario comes true, the Federal Reserve cannot lower interest rates far below zero and so cannot get to where it wants to be. Thus liftoff should wait until it is pretty damn clear that the hawk scenario is overwhelmingly more likely. And it is not overwhelmingly more likely now. The Fed is making a mistake. And Faust’s on-the-one-hand-on-the-other-hand without acknowledging the asymmetry in the situation…

Jon Faust: Liftoff? And then…: “The Fed’s policy projections going into the December FOMC last year showed a year-end 2015 median federal funds rate…

…of about 1.5 percent, with a range from zero to three percent. And the situation is almost the same this year: the funds rate is zero entering the December meeting, and the projections for year-end 2016 have a span of approximately zero to three percent, with a median just below 1.5 percent. More Groundhog Day than Christmas…. For the hawkish faction, the extraordinary accommodation that has long been in place is causing–or at least planting the seeds for–distortions and excesses, including inflation. In the main dovish scenario… any adverse development might be sufficient to push the economy into a pernicious deflation and require the Fed to dip deeper into the bag of unconventional tools…. By raising the federal funds rate now, the FOMC may counter some distortions and will make future rate increases less fraught should the hawk’s scenario come to pass. But raising rates inevitably entails some drag on Main Street…. What I’d most like for the holidays, of course, is for those projections of solid growth and accelerating inflation to come true, in which case we’ll all be toasting better times and more normal interest rates next holiday season.

Must-Read Pre-Liftoff Lollapalooza: Harriett Torry and Jon Hilsenrath: Lesson for Fed: Higher Interest Rates Haven’t Been Sticking

Posted on by Brad DeLong

Must-Read Pre-Liftoff Lollapalooza: Why does the Fed think that it will be different, and not desperately want to lower interest rates in two years, but be scared to admit it made a mistake? Much better to wait until you are sure that you will not have to return to zero in short order. Yet, somehow, that asymmetric-risks argument does not have purchase within the Fed…

Harriett Torry and Jon Hilsenrath: Lesson for Fed: Higher Interest Rates Haven’t Been Sticking: “Central banks in the eurozone, Sweden, Israel, Canada, South Korea, Australia, Chile and beyond…

…have tried to raise rates in recent years, only to reduce them again as their economies stumbled. Central-bank U-turns on rates in recent years had different causes and consequences…. The Bank of Israel, under Stanley Fischer, who is now the Fed’s vice chairman, was among the first to move. It started raising rates from 0.5% in September 2009, just as a global recovery took hold, pushing them up to 3.25% by May 2011. With Israel’s economy buffeted by Europe’s downturn and global inflation slowing, Mr. Fischer’s successor, Karnit Flug, has since pushed rates back down to 0.10%. Two central banks that haven’t raised rates since the crisis—the Fed and the Bank of England—have enjoyed stronger recoveries than others. Their patience might pay off. Their economies might now finally be healthy enough to bear higher rates…. “Tightening too early can have very large costs, as it has had in the Swedish case,” said Lars Svensson, who quit as Riksbank deputy governor in 2013 in protest at the bank’s policy decisions…

Must-Read Pre-Liftoff Lollapalooza: Robin Wigglesworth: How the US Federal Reserve Intends to Raise Rates

Posted on by Brad DeLong

Must-Read Pre-Liftoff Lollapalooza: Yes, the Federal Reserve has the tools it needs in order to liftoff interest rates. But how will it use its tools? How it is going to manipulate interest on reserves, the monetary base, reserve requirements, and the amount of duration risk it has taken off the private market will be very interesting to watch…

Robin Wigglesworth: How the US Federal Reserve Intends to Raise Rates: “Buckle up. On Wednesday, the Federal Reserve is expected to raise interest rates for the first time since 2006…

…and reversing the past seven years of extraordinary monetary policy looms as being an experimental, possibly bumpy lift-off. When economists talk about the Fed’s official borrowing rate, they refer to the Fed funds rate, which since late 2008 has been confined to a corridor between zero and 0.25 per cent…. The Fed funds rate sets a benchmark for the cost of credit that ripples through markets and guides borrowing costs for everyone in the US (and much further afield)….

Acting as a floor for now at 0.05 per cent, the overnight reverse repo programme, or Overnight RRP, is primarily aimed at money market funds, and is expected to do much of the heavy lifting. In a typical RRP the Fed’s market desk sells a Treasury bond from its portfolio to a money-market fund and agrees to buy it back the next day at a certain price, a process known as ‘repo’, short for repurchase. In practice, the central bank’s balance sheet does not shrink, but this sets a benchmark for cash interest rates paid by the Fed itself. These RRP operations will happen every business day between 12.45pm and 1.15pm in New York…. Currently the RRP programme is capped at $300bn to avoid the Fed’s operations distorting money markets, but economists expect its size to have to be expanded… to be enlarged to $750bn to $1tn, or perhaps be unlimited in size to ensure a smooth lift-off….

Some economists argue that the Fed should look for a new mechanism to set US interest rates, since the Fed funds market is so small and thinly traded nowadays. There used to be close to $350bn a day that changed hands before the crisis, but daily volumes are now roughly $50bn a day. Some are therefore urging a radical rethink. Even Simon Potter, head of the New York Fed’s markets division — and thus the man that will have to implement the central bank’s decision — hinted that this may be needed…. Fed officials are confident they have the tools to raise the Fed funds rate to roughly where they want it, and while the recent rash of market abnormalities has raised eyebrows, most expect other important interest rates to rise in conjunction. But it could still be a bumpy take-off.

Must-Read Pre-Liftoff Lollapalooza: Financial Times: The Federal Reserve May Be Jumping the Gun

Posted on by Brad DeLong

Must-Read Pre-Liftoff Lollapalooza: The Financial Times editors argue that the Federal Reserve is making a mistake with tomorrow’s liftoff of interest rates.

They are right.

The only wrong thing they say that I see is their statement that “it would probably be more disruptive if the Fed sat on its hands”. The Fed is likely to have to break its policy commitments at some point because its policy commitments are dangerous and faulty. Given that, the least disruptive moment to break them is now. Breaking them later will only be more disruptive.

Financial Times: The Federal Reserve May Be Jumping the Gun: “Just because it seems inevitable does not mean it is a good idea…

…The Federal Reserve’s Open Market Committee, which on Wednesday announces its decision on interest rates, has widely telegraphed that it will raise borrowing costs for the first time since 2006 after seven years on hold. Janet Yellen, the Fed chair, has apparently overcome opposition from some more dovish members on the central bank’s governing board…. The Fed will, on balance, be moving too early…. The value of waiting outweighs that of acting now…. Year after year, the Fed… has overestimated inflationary pressure, suggesting either a miscalculation about the economy’s output capacity or something even more fundamental going wrong. While American unemployment is low… the US’s number of economically inactive people [is high]… discouraged workers who have left the labour market never to return, or they may be people who would start looking for a job if the offers were there…. With consumer price inflation having undershot its informal 2 per cent target for so long, there is a good case for remaining behind the curve until it is quite clear which way the curve is moving.

Having come this far in signalling that interest rates are about to rise, it would probably be more disruptive if the Fed sat on its hands on Wednesday than if it moved…. Yet at the very least it should do its utmost to make clear that this is not the first in a series of preordained interest rate rises. In that sense, too, it needs to make a break with historical precedent in which the first US rate rise is reliably followed by a string of further moves. If it does raise rates, the Fed should signal that it stands ready to reverse course…. The central bank should leave interest rates on hold this week.

Must-Read: Mark Thoma: Why It’s Tricky for Fed Officials to Talk Politically

Posted on by Brad DeLong

Must-Read: I would beg the highly-esteemed Mark Thoma to draw a distinction here between “inappropriate” and unwise. In my view, it is not at all inappropriate for Fed Chair Janet Yellen to express her concern about excessive inequality. Previous Fed Chairs, after all, have expressed their liking for inequality as an essential engine of economic growth over and over again over the past half century–with exactly zero critical snarking from the American Enterprise Institute for trespassing beyond the boundaries of their role.

But that it is not inappropriate for Janet Yellen to do so does not mean that it is wise. Mark’s argument is, I think, that given the current political situation it is unwise for Janet to further incite the ire of the nutboys in the way that even the mildest expression of concern about rising inequality will do.

That may or may not be true. I think it is not.

But I do not think that bears on my point that Michael R. Strain’s arguments that Janet Yellen’s speech on inequality was inappropriate are void, wrong, erroneous, inattentive to precedent, shoddy, expired, expired, gone to meet their maker, bereft of life, resting in peace, pushing up the daisies, kicked the bucket, shuffled off their mortal coil, run down the curtain, and joined the bleeding choir invisible:

Mark Thoma: Why It’s Tricky for Fed Officials to Talk Politically: “I think I disagree with Brad DeLong…

…Should speeches by Federal Reserve officials be limited to topics concerning monetary policy and financial stability, or should they be free to speak on any topic, no matter how politically charged it might be? It’s an important question as the Fed prepares to announce next week what’s looking like a significant change in its eight-year policy of zero-perecent interest rates.
Fed Chair Janet Yellen, for example, was sharply criticized for a speech last year highlighting what economists know about rising inequality and what might be done to overcome it.
This speech, which Yellen gave in October 2014, is still creating controversy. This week, it erupted again when UC Berkeley economist Brad DeLong defended Yellen against the charge that she’s a ‘partisan hack,’ a description in the headline of a Washington Post story by Michael Strain after Yellen’s speech…

Must-Read: Tim Duy: And That’s a Wrap

Posted on by Brad DeLong

Must-Read: The principal question the Federal Reserve should be discussing right now is: When the next adverse macro economic shock comes, the Fed needs to be in a position to cut the federal funds rate by up to 500 basis points. What should we be doing now to create an economy as fast as possible that is strong enough to allow for such a federal funds rate? Yet I am seeing no chatter around this question at all. Perhaps the silence is simply a consensus of despair?

Tim Duy: And That’s a Wrap: “The service sector number continues to bounce around a respectable range…

…A bit less so for… manufacturing…. The Fed is betting that a.) this data is noisy and b.) that the service sector is much, much more important to the economy than manufacturing and c.) some of the weakness in manufacturing will be alleviated as the oil/gas drilling and export drag soften over the next year in relative terms. Speaking of exports, the trade report came with a larger-than-expected deficit, a factor that added another hit to GDP nowcasting…. The Atlanta Federal Reserve Bank’s GDPnow indicator is currently tracking at 1.5%…. No fear, though… Janet Yellen… highlighted total real private domestic final purchases as the number to watch:

Growth this year has been held down by weak net exports…. By contrast, total real private domestic final purchases (PDFP)… has increased at an annual rate of 3 percent this year….

That sent everyone to FRED (the code is LB0000031Q020SBEA)…. When they search through the data for the happy numbers, you know they are looking to hike. Indeed, the clear takeaway from Yellen’s speech was that a rate hike was coming….

We are now well beyond the issue of the first rate hike. The new questions are how gradual will ‘gradual’ be and when will the Fed begin widening down the balance sheet…. Federal Reserve Governor Lyle Brainard argued to hold the balance sheet at current levels until interest rates are sufficient to provide a cushion for the next recession…. Brainard knows she has lost the battle to forestall the first rate hike further and has now chosen to stake out a position on one of the next big issues…. The pace of subsequent tightening, the normalization–or not–of the balance sheet, and the countdown to the next easing are all issues now on the table.

Marginal Notes on Janet Yellen’s Footnote 14

Posted on by Brad DeLong

The answer to the last point Janet Yellen makes in her famous Footnote 14 is:

  • If is indeed the case that targeting an inflation rate of 4%/year “stretch[es] the meaning of ‘stable prices’ in the Federal Reserve Act”, then targeting an inflation rate of 2%/year does not stretch the meaning of but rather eliminates the “maximum employment” objective in the Federal Reserve Act. Congress has left the Federal Reserve freedom to deal as best as it can with an imperfect world in which all of the statutory objectives cannot be achieved perfectly. It is the Fed’s choice how to balance.

The answers to her other points are:

  • If it is indeed that case that “changing the FOMC’s long-run inflation objective would risk calling into question the FOMC’s commitment to stabilizing inflation at any level…” failing to change does not risk but does call into question the FOMC’s commitment to maximum employment and to financial stability as well.

  • If it is indeed that case that “it is not obvious that a modestly higher target rate of inflation would have greatly increased the Federal Reserve’s ability to support real activity…” it is still the case that a higher inflation target allows the Federal Reserve to achieve the same degree of monetary ease measured in terms of real interest rates without putting nearly as much adverse and unfortunate pressure on the commercial banking system’s finances. A Federal Reserve that seeks–as it should–to both use monetary policy to support increased real activity as well as avoid putting undue destructive pressure on the commercial banking sector should welcome the additional sea room provided by a higher inflation target, even if the benefits from lower real interest rates in terms of supporting real activity are only modest.

  • If it is indeed the case that the Federal Reserve is confident that it can “use large-scale asset purchases and other unconventional tools to mitigate the costs arising from the ELB constraint…” the Federal Reserve is unique in being the only organization of economists that possesses such confidence.

  • And, last, it is indeed the case that the “earlier analyses of ELB costs” that underpinned the decision to adopt 2%/year as an inflation target “significantly underestimated the likelihood of severe recessions and slow recoveries of the sort recently experienced…” A policy choice substantially based on the wrong assumptions is highly likely to be exchanged at some point for one based on the right assumptions. And the sooner the shift is made, the better–both in terms of avoiding the costs of having bad policy, and avoiding the costs of uncertainty and lack of credibility generated by claiming a credible commitment to permanently pursue a not-very-credible policy.

Janet Yellen: Footnote 14: “Blanchard, Dell’Ariccia and Mauro (2010), among others…

…have recently suggested that central banks should consider raising their inflation targets, on the grounds that conditions since the financial crisis have demonstrated that monetary policy is more constrained by the effective lower bound (ELB) on nominal interest rates than was originally estimated. Ball (2013), for example, has proposed 4 percent as a more appropriate target for the FOMC. While it is certainly true that earlier analyses of ELB costs significantly underestimated the likelihood of severe recessions and slow recoveries of the sort recently experienced in the United States and elsewhere (see Chung and others, 2012), it is also the case that these analyses did not take into account central banks’ ability to use large-scale asset purchases and other unconventional tools to mitigate the costs arising from the ELB constraint.

In addition, it is not obvious that a modestly higher target rate of inflation would have greatly increased the Federal Reserve’s ability to support real activity in the special conditions that prevailed in the wake of the financial crisis, when some of the channels through which lower interest rates stimulate aggregate spending, such as housing construction, were probably attenuated. Beyond these tactical considerations, however, changing the FOMC’s long-run inflation objective would risk calling into question the FOMC’s commitment to stabilizing inflation at any level because it might lead people to suspect that the target could be changed opportunistically in the future. If so, then the key benefits of stable inflation expectations discussed below–an increased ability of monetary policy to fight economic downturns without sacrificing price stability–might be lost.

Moreover, if the purpose of a higher inflation target is to increase the ability of central banks to deal with the severe recessions that follow financial crises, then a better strategic approach might be to rely on more vigorous supervisory and macroprudential policies to reduce the likelihood of such events. Finally, targeting inflation in the vicinity of 4 percent or higher would stretch the meaning of ‘stable prices’ in the Federal Reserve Act…

Must-Read: Paul Krugman: Anchors Aweigh

Posted on by Brad DeLong

Must-Read: The answer, presumably, is the same as it was in the 1960s and 1970s: that “too big” a deviation from the anchored level of inflation for “too long” will de-anchor inflation, for weasel parameters “too big” and “too long”.

It has always seemed to me that if inflation expectations are “well anchored”, then monetary policy is obviously too tight. There are very powerful upsides from a higher-pressure economy. There are no downsides unless inflation expectations are barely-anchored–in which case a higher-pressure economy runs the risk of de-anchoring them, with associated costs. But with well-anchored inflation expectations there is a substantial amount of slack somewhere in the policy-optimization problem. And no professional economist should be happy or comfortable with such an outcome.

Paul Krugman: Anchors Away: “Since 2008… demand-side events have been very much what people using IS-LM would have predicted (and did)…

…But on the supply side, not so much…. Model-oriented public officials and research staff at policy institutions… [now] say… they work with… ‘anchored’ expectations… [which] don’t change their expectations in the face of recent experience… like the old, pre-NAIRU Phillips curves people estimated in the 1960s. And… such curves fit pretty well on data since 1990….

Where does anchoring come from and how far can it be trusted? Is it the consequence of central bank credibility, or is it just the consequence of low inflation?… Second… the anchored-expectations hypothesis tells a very different story about capacity and policy…. Let me illustrate this point with the case of the euro area…. Euro core inflation is currently about 1 percent; the slope of the Phillips relationship is around 0.25; so getting back to 2 should require a 4 percentage point fall in unemployment. That’s a lot! How much output growth would this involve?… This naive calculation puts the euro area output gap at 8 percent, which is huge. Should we take this seriously? If not, why not?

Anchors Away Slightly Wonkish The New York Times

http://krugman.blogs.nytimes.com/2015/12/04/anchors-away-slightly-wonkish/

Must-Read: Greg Ip: The False Promise of a Rules-Based Fed

Posted on by Brad DeLong

Must-Read: It does boggle my mind that John Taylor and Paul Ryan would take the 2004-today experience as suggesting that the Federal Reserve should be even loosely bound by any sort of policy “rule”:

Greg Ip: The False Promise of a Rules-Based Fed: “That suggests two possible outcomes…

…One, the Fed will repeatedly change the rule or deviate from it, which defeats the supposed purpose of the rule, which is for the Fed be predictable and constant. Or the Fed, to avoid invasive audits by Congress, might stick to the rule longer than it should until the economic consequences are intolerable. Stanley Fischer… once said of exchange-rate rules: ‘The only sure rule is that whatever exchange-rate system a country has, it will wish at some times that it had another one.’ Similarly, history suggests that if the Fed is forced to adopt a rule for monetary policy, it will eventually have to abandon it. The only question is how costly that process is likely to be.