Tag: Monetary Policy

Must-read: Donald Kohn and David Wessel: “Eight Ways to Improve the Fed’s Accountability”

Posted on by Brad DeLong

Must-Reads: Perhaps the most frustrating thing about monetary policy making since the taper tantrum has been that we outsiders find that (a) asymmetric risks plus (b) uncertainty about the true state of the labor market and (c) uncertainty about the position and slope of the Phillips Curve are dispositive. They make the case for keeping the monetary-expansion pedal to the metal overwhelming. Yet the Federal Reserve has not felt compelled to engage with outsiders making these arguments in any sustained and deep technocratic way. And those doing oversight at congress have been incapable of doing the job–what we have seen has been either blathering or, worse, ravings about the gold standard.

The extremely-sharp Don Kohn and David Wessel have good suggestions for procedural reform:

Donald Kohn and David Wessel: Eight Ways to Improve the Fed’s Accountability: “1. The Fed should… have monetary policy hearings quarterly…

…2. The now semi-annual Monetary Policy Report… should become quarterly…. 3. The Fed should publicly release the Monetary Policy Report three days before the relevant hearing…. 4. The Monetary Policy Report should continue to include the Fed’s assessment of financial stability risks…. 5. Fed staff should continue to brief and field questions from the congressional staff…. 6. Congress should establish a process for obtaining and publishing the views of outside experts…. 7. Each quarterly hearing in the House should allow only half the committee members to question the chair…. 8. The Fed should hire outside experts to periodically evaluate the procedures used to generate… economic projections….

None of these suggestions would reduce the Fed’s independence. Rather, they would improve Congress’s oversight and the Fed’s accountability, at a time when our economic discourse would greatly benefit from better public understanding and increased confidence in the efficacy and appropriateness of the central bank’s actions.

Must-read: Paul Krugman sending us to Gavyn Davies, Lael Briainard from last October, and himself from a year ago

Posted on by Brad DeLong

Must-Read: James Fallows will be upset as I buy into the myth of the boiling frog. The Federal Reserve’s decision to raise interest rates last December was, it thought, a marginal move that was running a small risk. But as evidence has piled in suggesting that the risks on the downside are larger and larger, the Federal Reserve has done… nothing…

Paul Krugman orders and inspects the arguments:

Paul Krugman sends us to Gavyn Davies, Lael Briainard from last October, and himself from a year ago:

  • Gavyn Davies today: The Fed and the Dollar Shock: “The dismal performance of asset prices continued…. The weakening US economy. This weakness seems to be in direct conflict with the continued determination of the Federal Reserve to tighten monetary policy. Janet Yellen’s… attitude was deemed by investors to be complacent about US growth. (See Tim Duy’s excellent analysis of her remarks here.) Why is the Federal Reserve apparently reluctant to respond to the mounting recessionary and deflationary risks faced by the US? It is human nature that they are reluctant to admit that their decision to raise rates in December was a mistake. Furthermore, they believe that markets are often volatile, and the squall could yet blow over. But I suspect that something deeper is going on. The FOMC may be underestimating the need to offset the major dollar shock that is currently hitting the economy…”

  • Lael Brainard: Economic Outlook and Monetary Policy–October 12, 2015: “The risks to the near-term outlook for inflation appear to be tilted to the downside…. Over the past year, a feedback loop has transmitted market expectations of policy divergence between the United States and our major trade partners into financial tightening in the U.S. through exchange rate and financial market channels…. The downside risks make a strong case for continuing to carefully nurture the U.S. recovery–and argue against prematurely taking away the support that has been so critical to its vitality…. These risks matter more than usual because the ability to provide additional accommodation if downside risks materialize is, in practice, more constrained than the ability to remove accommodation more rapidly if upside risks materialize…”

  • Paul Krugman: The Dollar and the Recovery: “Consider two pure cases of rising US demand…. #1, everyone sees the relative strength of US spending as temporary…. In that case the dollar doesn’t move, and the bulk of the demand surge stays in the US…. #2, everyone sees the strength of US spending relative to the rest of the world as more or less permanent. In that case the dollar rises sharply, effectively sharing the rise in US demand more or less evenly around the world. It’s important to note, by the way, that this is not just ordinary leakage via the import content of spending; it works via financial markets and the dollar, and happens even if the direct leakage through imports is fairly small. So, what’s actually happening? The dollar is rising a lot, which suggests that markets regard the relative rise in US demand as a fairly long-term phenomenon…. The strong dollar probably is going to be a major drag on recovery.”

Must-read: Tim Duy: “Fed Yet to Fully Embrace a New Policy Path”

Posted on by Brad DeLong

Must-Read: Tim Duy: Fed Yet to Fully Embrace a New Policy Path: “The Fed will take a pause on rate hikes. An indefinite pause…

…The sooner they admit this, the better off we will all be. Indeed, the sooner they admit this, the sooner financial markets will calm and the sooner they would be able to resume hiking rates. Federal Reserve Chair Janet Yellen had two high profile opportunities this week to make such an admission. Yet she failed to do so….

By the end of 2015, the economy was near full-employment…. A combination of factors would work in tandem to slow activity… higher dollar, higher inflation, higher wages, and higher short term interest rates (tighter monetary policy). How much monetary policy tightening is consistent with the new equilibrium depends on the evolution of the other prices. A reasonable baseline at the end of last year was that 100bp of tightening would be consistent with achieving full-employment. That was the Fed’s starting point as well….

A key factor in keeping the US economy on the rails is acknowledging that tightening financial conditions via the dollar obviates the need to tightening conditions via monetary policy…. But the Fed has yet to fully embrace this story. And that leaves them sounding relatively hawkish…. Yellen & Co. don’t need to emphasize the direction of rates. They just can’t stop themselves. Worse yet, they feel compelled to describe the level of future rates via the Summary of Economic Projections. A level entirely inconsistent with signals from bond markets, no less. They don’t really know what the terminal fed funds rate will be, so why keep pretending they do? The ‘dot plot’ does nothing more than project an overly-hawkish policy stance that leaves market participants persistently fearful a policy error is in the making. It is time to end the ‘dot plot.’ 

Must-read: Amir Sufi: “Household Debt, Redistribution, and Monetary policy during the Economic Slump”

Posted on by Brad DeLong

Must-Read: Amir Sufi: Household Debt, Redistribution, and Monetary policy during the Economic Slump: “High-income and low-income individuals respond very differently to monetary policy shocks…

…as do savers and borrowers. Monetary policy has been especially weak in advanced economies over the past seven years because the redistribution channels of monetary policy have been severely hampered. Recognising the importance of such channels can guide central bankers on what monetary policies are most likely to be effective: the same policy may have different effects on the real economy depending on the distribution of debt capacity across individuals.

Weekend reading: Narayana Kocherlakota: “Dovish Actions Require Dovish Talk (To Be Effective)”

Posted on by Brad DeLong

The wise Mark Thoma sends us to the newly-unmuzzled and very sharp 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 for the past eight years.  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).   Does that experience mean that we should give up on monetary policy as a useful way to stimulate aggregate demand?
My answer is no.  I argue that, 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.  Future monetary policy stimulus can be considerably more effective if the FOMC is much more transparent about its willingness to support the economy – that is, about its true dovishness.

My starting point is that households and businesses don’t make their decisions about spending based on the current fed funds rate – which, is after all, a one-day interest rate.  Rather, spending decisions are based on longer-term yields.  Those longer-term yields depend on market participants’ beliefs about how monetary policy will evolve over the next few years.  Those beliefs are a product of both FOMC actions and FOMC communications. 

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. (Full disclosure: I took part in FOMC meetings from November 2009 through October 2015, and it could certainly be argued that I was part of the problem that I describe until September 2012.)  

I’ll illustrate my basic point in the most extreme way that I can.  In November 2009, the Committee’s statement said that the fed funds rate might be raised after ‘an extended period’ – a term that was generally interpreted to mean ‘about six months’.  Accordingly, as footnote 25 of this speech notes, private forecasters in the Blue Chip survey projected that the unemployment rate would be near 10 percent at the time of the first interest rate increase.  

Now, suppose that the FOMC had communicated its true reaction function in November 2009 (or even as late as December 2012): as long as inflation was anticipated to be below 2% over the medium-term, the Committee would not raise the fed funds rate until the unemployment rate had fallen to 5% or below.  We can’t know the impact of such communication with certainty.   But most macroeconomic models would predict that this kind of statement would have put significant upward pressure on employment and prices.  In other words: the models predict that if the FOMC had been willing to communicate its true willingness to support the economy, the Committee would have been able to (safely) raise rates much sooner.  

I want to be clear: my point in this post is not to express regrets or recrimination over past ‘mistakes’.    (It would have been good in 2009 to know what we know now, but we didn’t.)  And my point is not that monetary policy is some kind of panacea.  In the presence of a lower bound on nominal interest rates, expansionist fiscal policy would have been helpful in the past (and could be now too). 

My point is this: we shouldn’t make judgements about the efficacy of future monetary policy stimulus based on the experience from the past seven years.   Unfortunately, much of the potential impact of that lengthy stimulus campaign was vitiated by the FOMC’s generally hawkish communications.   

In my view, the FOMC can deliver useful impetus to aggregate demand with its remaining tools.  But it needs to communicate ahead of time about its true willingness and ability to support the economy.   Without that prior communication, later attempts at stimulus are likely to prove in vain – and the Fed’s credibility may suffer further damage.

Must-read: Antonio Fatas: “A 2016 Recession Would Be Different”

Posted on by Brad DeLong

Must-Read: “The years that the locust hath eaten, the cankerworm, and the caterpiller, and the palmerworm…” –Joel 2:25 (KJV). The task of fiscal and monetary policymakers as of the start of 2009 was (1) to arrest the slide, (2) to trigger a strong recovery, and (3) to set the world economy in a situation in which future policymakers would have the room to maneuver so that future substantial adverse macroeconomic shocks–and there would be future substantial adverse macroeconomic shocks–could be neutralized. They (probably) accomplished (1), they (certainly) failed at (2), and they continue to fail at even starting at (3)–and the fact that it is now seven years and they have not even started this task somehow fails to exercise them:

Antonio Fatas: A 2016 Recession Would Be Different: “1. The Yield curve would be very steep…

…2. The real federal funds rate (or the ECB real repo rate) would be extremely low…. 3. And nominal central bank interest rates would be stuck at zero…. So maybe this tells us that a recession is not about to happen. But if it is, the lack of space to implement traditional monetary policy tools should be a big concern for policy makers. If a recession ends up happening, helicopter money will likely become a policy option.

Must-read: Tim Duy: [Stan Fischer] “Resisting Change?”

Posted on by Brad DeLong

Must-Read: Two takeaways this morning from Stan Fischer, and from Tim Duy reading Stan Fischer:

  1. 1.4%-2% inflation “positive and broadly consistent with price stability” “not in another universe [from 2%]… not a negative number” is the new 2% inflation target.

  2. Because the Federal Reserve has no confidence in its ability to nudge the unemployment rate up to its long-run NAIRU level without overshooting and causing a recession, it must always attempt to glide down to the NAIRU from above–and must not follow policies that risk pushing unemployment below the NAIRU, whatever it really is:

Tim Duy and Friends: [Stan Fischer] Resisting Change?](https://twitter.com/TimDuy/status/694715619929780224): https://t.co/2g24mCkTzv

Lance Bachmeier: @kocherlakota009 @TimDuy: “Good post…

…SF/EG (inadvertently?) communicate that 1.5-2% inflation is ‘good enough’ for them.

NRKocherlakota: “@TimDuy Problem: if 2% is the true symmetric…

…target of policy, the FOMC needs a U-Turn, not just a pause: https://sites.google.com/site/kocherlakota009/home/policy/thoughts-on-policy/1-21-16

Tim Duy: “@kocherlakota009 So…

…I don’t really believe the target is symmetric. Need to prove it to me.

NRKocherlakota: “@TimDuy Yes, and I worry that public/markets…

…have your same (reasonable!) doubts. SF’s and EG’s remarks don’t help assuage those doubts.

Lance Bachmeier: “@kocherlakota009 @TimDuy The strange thing…

…is that they’re lowering the [inflation] target after we’ve learned 2% is too low already.

Lance Bachmeier: “@kocherlakota009 @TimDuy I’m not even sure 2% is a ceiling…

…they want to prevent inflation from [even] reaching 2%.

Tim Duy: Resisting Change?: “Stanley Fischer[‘s]… speech… was both illuminating and frustrating…. Although his confidence is fading… he is resisting change…. The first source of my frustration… [is that] his definition of ‘accommodative’ depends upon a specific idea of the neutral Fed Funds rates. From the subsequent discussion:

Well, I think we have to wait to see…. We expect…. somewhere around 3 ¼, 3, 3 ½ percent, which is on average a bit lower than in the past. But we’ll be data-dependent….

If you don’t know the longer-run rate, how can you know how accommodative policy is? If the longer-run rate is close to 2 percent, then policy is less accommodative than you think it is. The endgame of policy is the dual employment/price stability mandate, not a specific level of interest rates…. [That the] Fed’s forecasts… have been foiled by oil and the dollar… would suggest a slower or delayed pace of rate hikes, but more on that later. As for market volatility and external events:

In addition, increased concern about the global outlook, particularly the ongoing structural adjustments in China and the effects of the declines in the prices of oil and other commodities on commodity exporting nations, appeared early this year to have triggered volatility in global asset markets. At this point, it is difficult to judge the likely implications of this volatility. If these developments lead to a persistent tightening of financial conditions, they could signal a slowing in the global economy that could affect growth and inflation in the United States. But we have seen similar periods of volatility in recent years that have left little permanent imprint on the economy.

This is unimpressive…. The likely implications of the volatility are straightforward. The decline in longer term yields signals the Fed is likely to be lower for longer…. It seems that Fischer does not acknowledge the Fed’s role in minimizing the impact of similar bouts of volatility. They have responded by either easing via additional quantitative easing, or easing by delaying tightening…. When you fail to recognize your role, you set the stage for a policy error. They can’t use the logic that they should hike in March because past volatility had no impact on growth when that same volatility actually changed their behavior and thus the economic outcomes. I guess they can use that logic, but they shouldn’t. So is March on the table still?… I can tell a story where they push ahead on the labor data alone. Back to Fischer….

A persistent large overshoot of our employment mandate would risk an undesirable rise in inflation that might require a relatively abrupt policy tightening, which could inadvertently push the economy into recession. Monetary policy should aim to avoid such risks and keep the expansion on a sustainable track….

Policymakers fear that they cannot allow unemployment to drift far below the natural rate because they do not believe they could just nudge it back higher without causing a recession. They can only glide into a sustainable path from above… [thus] the Fed will resist holding rates steady…. Indeed, one voting member is already working hard to downplay recent events. Today’s speech by Kansas City Federal Reserve President Esther George:

While taking a signal from such volatility is warranted, monetary policy cannot respond to every blip in financial markets. Instead, a focus on economic fundamentals, such as labor markets and inflation, can help guard against monetary policy over- or under- reacting to swings in financial conditions. To a great extent, the recent bout of volatility is not all that unexpected, nor necessarily worrisome, given that the Fed’s low interest rate and bond- buying policies focused on boosting asset prices as a means of stimulating the real economy. As asset prices adjust to the shift in monetary policy, it is to be expected that the pricing of risk will realign to this different rate environment…. If we wait for the data to provide complete confirmation before making a policy decision, we may well have waited too long….

Watch for policymakers to downplay the inflation numbers as well. Back to George:

Finally, inflation has remained muted as a result of lower oil prices and the strong U.S. dollar…. Yet… core measures of inflation have recently risen on a year-over-year basis. And although inflation rates… have hovered below the Fed’s goal of 2 percent, they have been positive and broadly consistent with price stability.

Note the ‘positive and broadly consistent’ line. And Fischer:

And our view of progress is what the law calls maximum employment and what we call maximum sustainable employment, and a 2 percent inflation rate. And when we get there—we’re there—we’re very close to there on employment, and on inflation the core number that came out this morning was 1.4 percent. You know, that’s not 2 percent. It’s not in another universe. It’s not a negative number. But inflation’s been pretty stable, and we’d like it to go up.

Not in ‘another universe’ from 2 percent. Not negative. Sure we’d like it to go up, but are we really worried about it? Doesn’t sound like it to me.

Bottom Line…. I suspect market volatility and lack of inflation data keep them on hold in March and maybe April…. However (although not my baseline), I can tell a story where they feel like the employment data forces their hand. Especially so if they continue to downplay the inflation numbers. A substantial part of their policy still appears directed by a pre-conceived notion of ‘normal’ policy. This I think is the Fed’s largest error; the fact that the yield curve stubbornly resists being pushed higher suggests that the Fed’s estimates of the terminal fed funds rates is wildly optimistic. There appear to be limits to which the Fed can resist the global pull of zero (or lower) rates.

Must-read: Martin Sandbu: “Four Takes on the Fed Fumble”

Posted on by Brad DeLong

Must-Read: That the Fed would be facing significant chances of recession and would be moving in the opposite policy direction than its peers over the winter was a serious risk of beginning a tightening cycle in December, and a risk that has now risen from a possibility to a probability.

What was the countervailing serious risk that starting the tightening cycle in December took off the table? I really do not see it…

Graph 5 Year 5 Year Forward Inflation Expectation Rate FRED St Louis Fed

Martin Sandbu: Four Takes on the Fed Fumble: “Remember September? Markets seemingly couldn’t wait for the Federal Reserve to raise interest rates…

…Now, however, markets seemingly can’t wait for the Fed to definitively snip the fledgling tightening cycle in the bud. And a growing chatter wonders whether the Fed made a mistake…. Market pricing now implies nearly a two-thirds probability that Fed policymakers will get past next September without a single further rate rise. The change in market sentiment is easy enough to understand… financial turmoil in China… slide in global stock markets… sharp US growth slowdown…. There are (at least) four different ways one may assess the Fed’s actions. First, the plain ‘the Fed goofed up’ view… Paul Krugman, Brad DeLong and Larry Summers. Free Lunch readers will know that this column shares their view on this issue… Jed Graham….

A second, perhaps more interesting, take is that in hindsight the Fed shouldn’t have raised rates, but that it couldn’t have known this at the time…. A third take… the mistake was to create expectations that caused financial conditions to tighten long before December…. A fourth view… the Fed was right to hike but wrong in thinking it would then proceed to lift rates through this year…. But… the arguments for a rise were… for the beginning of a sustained if gradual process. If that is now derailed, it removes much of the rationale for the first increase.

It also leaves open the question of what to do next…. Should the Fed reverse course? That is the view of Narayana Kocherlakota…

Must-read: Jed Graham: “The Fed’s Historic Rate-Hike Goof–in One Chart”

Posted on by Brad DeLong

Must-Read: The very-sharp Jed Graham has… strong views… about the Federal Reserve’s rather counterintuitive decision to raise interest rates in a quarter at which nominal GDP grew at a rate of 1.5%/year, at the end of a year in which nominal GDP grew at 2.9%. The Fed is placing an awful lot of weight on the unemployment rate, and not on either non-labor market indicators or the employment-to-population ratio, in its decision to raise. I don’t think we even have to reach for the (very true and powerful) arguments about asymmetric risks to find the interest-rate increase technocratically incomprehensible, and the failure to roll it back last month technocratically incomprehensible as well:

The Fed s Historic Rate Hike Goof In One Chart Stock News Stock Market Analysis IBD

Jed Graham: The Fed’s Historic Rate-Hike Goof–in One Chart: “Janet Yellen’s Federal Reserve has done something that no other Fed has done since Paul Volcker…

…aimed to quash runaway inflation in the early 1980s, even if it meant a recession–and it did…. Nominal GDP grew at a 1.5% annualized rate in the fourth quarter…. (Inflation-adjusted GDP rose just 0.7% in Q4.) With the exception of Volcker’s interest-rate hike in early 1982 amid a recession, no other Fed has raised rates during a quarter in which nominal GDP grew less than 3%, dating back to the early 1970s. In fact, a rate hike when nominal GDP is growing less than 4%… from 1983 to 2014, it only happened twice, and one of those times (the second quarter of 1986), the Fed cut rates by a half-point before retracting 1/8th of a point of the reduction…. The first quarter of 1995, when nominal GDP grew 3.7%, [is] the only time since Volcker that the Fed had, on net, raised rates in a quarter when nominal growth was running below 4%. After that early 1995 hike, it should be noted, the Fed proceeded to cut rates three times before the next rate hike…. If one looks at the pace of GDP growth from the year-earlier quarter, the Yellen Fed stands alone as the only Fed to hike rates when nominal growth was below 3%.

Skidelsky on “The Two Big Economic Policy Failures That John Maynard Keynes Would Be Disappointed by Today”

Posted on by Brad DeLong

I missed this six months ago:

Julie Verhage: The Two Big Economic Policy Failures That John Maynard Keynes Would Be Disappointed by Today: “The famous economist isn’t around for us to ask him…

…but here is probably the next best thing. Robert Skidelsky… said… Keynes would have found two things upsetting. First, he would be frustrated with the lack of  precautions taken to prevent a huge financial crash like the one we saw in 2008. Secondly, Lord Skidelsky believes Keynes… would have wanted a more ‘buoyant response,’ he said.  Specifically, he doesn’t think Keynes would have liked the Federal Reserve’s quantitative easing….

We’ve been for many years in a state of semi-stagnation, and the recovery is still very very weak in the European Union. The actual recovery measures we’ve taken, particularly quantitative easing, have actually skewed the recovery towards asset buying and real estate, thus threatening to recreate the circumstances that led to crash in the first place. I think he would have been disappointed by those policy failures…

Skidelsky is certainly correct in saying that Keynes would be driven raving mad by the failure of central banks and other regulatory agencies to take seriously the task of managing and bounding the illusion of collective liquidity, in order to curb the dangers created by systemic risk. And he is correct in believing that Keynes would be astonished at counterproductive fiscal austerity and incoherent worries about debt burdens at a time of extraordinarily low current and projected future interest rates.

But I am puzzled by Skidelsky’s third. He believes that Keynes would have seen not a second- but a first-order loss in responding to tighter-than-ideal fiscal policy with looser-than-ideal monetary policy in order to hold aggregate demand harmless. Good Belsky does not, and to my knowledge nobody has succeeded in, producing a coherent simple model of what they mean. I am going to have to put this down as yet another example of a case in which smart, sensible people claim to know more and know different then what is in the simple file-and-communications systems that are our standard economic models.

I can see that responding to inappropriately-austere fiscal policy with easier monetary policy and lower interest rates than in the first-best creates a world with too-little government capital, too-low a level of social insurance spending, an inappropriately low level of government-provided safe assets, and on inappropriately-high level of long-duration risky assets.

What I do not see is why all of this is a first-order loss, and why it is worth opening up a significant Okun Gap relative to full employment and potential output in order to prevent these Harburger Triangles.

So, I am once again pleading for an answer, or an explanation, preferably in the form of a simple model I can wrap my brain around.

Crickets…