Sympathy for the devil

The Atlantic has a new article on Bernanke (by Roger Lowenstein) entitled “The Villain.”   The article itself praises Bernanke, saying the criticism from both the left and the right is unfair.

Matt Yglesias takes issue with Lowenstein:

No Mercy For Ben Bernanke

Ryan Avent has a good post that provides the following quotation from the Lowenstein article:

This might seem to support Krugman’s thesis that Bernanke would like to boost inflation but has chickened out. But after talking with the chairman at length (he was generally not willing to be quoted on this issue), I think that, although Bernanke appreciates the intellectual argument in favor of raising inflation, he finds more compelling reasons for not doing so. First is the fear that inflation, once raised, could not be contained.

Does Bernanke really believe this?  I doubt it.  Consider the following quotation, also from the Lowenstein article:

Though he recognizes the potential for inflation, he told 60 Minutes in December 2010 that he was “100 percent” certain of his ability to control it (a surprising, and troubling, certitude for a normally humble banker).

That’s the Bernanke that I favored for Fed chair back in 2006.  And since I’ve been so tough on him in this blog, let me say something good for a change.  I believe that Bernanke has come to the realization that if the US is going to get a robust recovery, we will need a bit higher inflation.  And I think this is starting to occur.  The “low rates until 2014″ policy is pretty meaningless as officially stated, but in my view the markets are able to read between the lines, and see that Bernanke is actually signaling; “we will hold rates near zero at levels of inflation and real growth that would have normally triggered rate increases.”  I agree with those (Ryan Avent?) who say the policy is neither fish nor fowl.  It’s not an unconditional commitment.  But it’s also not merely a commitment to hold rates at zero until 2014 unless the Fed model would normally call for a rate increase.  And I think markets have figured this out.  That’s why stocks have been strong in recent months, and 10 year bond yields are rising fast.  And yes, higher interest rates really do mean easier money, and are thus good news.

The TIPS spreads have risen to well over 2% on the 5 year and over 2.4% on the 10 year Treasury.  Those numbers may overstate actual inflation (according to the Cleveland Fed), but the trend is in the right direction.

So for now we seem to have turned a corner on monetary policy.  There is some risk that the Fed would tighten again during the summer (as during the summers of 2010 and 2011) if oil prices soared, but overall this is the first time in 4 years where I’ve felt that monetary policy is merely “too tight” not “much too tight.”

Alternatively we are no longer digging sideways; we actually seem to moving toward above trend growth in NGDP.  (That’s partly because the trend rate seems to have fallen below 4%.)  I’d still favor QE3, as it would speed up the recovery, and speed up the date at which we could go back to 26 week unemployment compensation.  But at least we seem to be entering a period where reasonable people could disagree.  For the last 3 1/2 years I’ve found myself mostly battling against unreasonable people, who were content to dig sideways.

PS.  I agree with Matt and Ryan that what the crisis really shows is a need for an NGDP target (level targeting.)  But then I guess that’s no surprise.  Even I would concede that it’s too late for this crisis.  What we really need is for the Fed to stop stress testing banks, and instead stress test its own ability to control AD in the next recession, when nominal rates are quite likely to again fall to zero.  I don’t see they’ve done that, but perhaps it’s an issue better examined in a non-crisis atmosphere, when the subject can be examined dispassionately.


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23 Responses to “Sympathy for the devil”

  1. Gravatar of Neal Neal
    16. March 2012 at 09:39

    If the Fed is tempted to tighten if oil prices rise, as in 2010 and 2011, have we really turned a corner on monetary policy?

  2. Gravatar of dwb dwb
    16. March 2012 at 10:04

    lets see if the “new framework” of publishing individual forecasts keeps the hawks from moving the markets when (and you know they will) jawbone.

    The structural issues (mortgage debt workouts) are also abating. The housing market is showing signs of life. Plus, there should be a lot of REO properties dumped on the rental market that will dampen housing-CPI.

    but, before i catch myself being optimistic, two months of middling jobs growth does not make a trend, let alone a good one.

  3. Gravatar of ssumner ssumner
    16. March 2012 at 10:47

    Neal, No.

    dwb, FWIW, I’m relying more on market forecasts, which seem increasingly optimistic.

  4. Gravatar of tom s. tom s.
    16. March 2012 at 11:02

    “perhaps [NGDP level targeting]is an issue better examined in a non-crisis atmosphere, when the subject can be examined dispassionately.”

    Perhaps then NGDP level targeting can be promoted as a solution to high inflation. That might be its best chance for public acceptance.

  5. Gravatar of Cthorm Cthorm
    16. March 2012 at 11:23

    What we really need is for the Fed to stop stress testing banks, and instead stress test its own ability to control AD in the next recession, when nominal rates are quite likely to again fall to zero. I don’t see they’ve done that, but perhaps it’s an issue better examined in a non-crisis atmosphere, when the subject can be examined dispassionately.

    I would prefer the Fed stop having regulatory responsibility altogether. The Fed should have a single purpose: maintain an effective monetary policy. Why does it make sense to give this Quasi-Sovereign agency authority over Banks? Why not give that authority more clearly to one of the several Federal agencies like the FDIC, where policy changes will be more public? If we have to have regulation (questionable) then it should at least be in the open.

  6. Gravatar of marcus nunes marcus nunes
    16. March 2012 at 11:31

    Scott
    I also took “issue”:
    http://thefaintofheart.wordpress.com/2012/03/16/bernanke-duels-bernanke-or-where%C2%B4s-the-real-bernanke/

  7. Gravatar of marcus nunes marcus nunes
    16. March 2012 at 11:34

    Scott. You said:
    “I believe that Bernanke has come to the realization that if the US is going to get a robust recovery, we will need a bit higher inflation. And I think this is starting to occur”.
    I have doubts:
    http://thefaintofheart.wordpress.com/2012/03/16/inflation-expectations-loosing-traction/

  8. Gravatar of marcus nunes marcus nunes
    16. March 2012 at 11:37

    Scott: You wrote:
    “The “low rates until 2014″ policy is pretty meaningless as officially stated, but in my view the markets are able to read between the lines, and see that Bernanke is actually signaling; “we will hold rates near zero at levels of inflation and real growth that would have normally triggered rate increases.”
    But it could also mean something much worse:
    “We expect the economy will remain weak going forward and so that everyone is on the same page we will keep the FF rate at exceptionally low levels for a long time. Or, even more “transparently”: Don´t expect us to act to change that expectation!”

  9. Gravatar of Bill woolsey Bill woolsey
    16. March 2012 at 11:39

    I hate the “we need more inflation” notion.

    We need spending on output to remain on a slow, stead growth path. If it has fallen, we “need” spending to rise more quickly. We never “need” more inflation.

    Targeting inflation is a bad idea always. If inflation would result with nominal spending on output on its slow study growth path, then pushing spending below that growth path to stop inflation is a very bad idea. But that isn’t because we “need” the inflation. What we need is to not restrict nominal spending on output below a stable growth path.

    Hawks? Doves? That is just wrongheaded nonsense. We need to keep spending on output on a slow, steady growth path rather than deciding how much inflation is needed, and talking about whether we are hawks or doves.

    The only relevant issue is whether we get nominal spending back to target fast (like a Hawk) or more slowly (like a dove.) Right now, with nominal spending well below trend, the “hawk” view is that we should get it back quick. The dove view would be to allow a slow glide path.

    But that isn’t what you mean.

    Now, if the Fed is trying to keep interest rates steady subject to the contraint that inflation not rise to high or unemployment rise to high, then… well, doesn’t this lingo make sense? Hawks worry about inflation and doves worry about unemployment.

    WRONG HEADED NONSENSE!

    You think the Fed is following the mainstream of economists? How about the reverse. The mainstream of economists are following the Fed.

  10. Gravatar of Wonks Anonymous Wonks Anonymous
    16. March 2012 at 11:39

    “That’s partly because the trend rate seems to have fallen below 4%”
    How do you determine that? If the Fed adopted a 5% level target, would you say they were pursuing too easy a policy which pushed above trend?

  11. Gravatar of marcus nunes marcus nunes
    16. March 2012 at 11:43

    @Bill Woolsey
    Man, you´re inspired today!

  12. Gravatar of dwb dwb
    16. March 2012 at 12:02

    I’m relying more on market forecasts, which seem increasingly optimistic.

    yes.

    http://finance.yahoo.com/echarts?s=XHB#chart3:symbol=xhb;range=5y;compare=^gspc;indicator=volume;charttype=line;crosshair=on;ohlcvalues=0;logscale=on;source=undefined

  13. Gravatar of Morgan Warstler Morgan Warstler
    16. March 2012 at 12:42

    You think the Fed is following the mainstream of economists? How about the reverse. The mainstream of economists are following the Fed.

  14. Gravatar of Cthorm Cthorm
    16. March 2012 at 13:07

    Gee Morgan, I have this eerie feeling that I’ve read that before…

  15. Gravatar of Justin Irving Justin Irving
    16. March 2012 at 13:34

    The Cleveland Fed inflation expecation numbers are a bit of puzzle. I once plowed through their methodology and belive them more accurate than raw TIPS spreads. Still, 1.4% on the 10 year for 6odd months now, even as employment climbs. The way I see it, markets are betting on 4% NGDP growth from here on out and also discounting future recessions where the political costs of QE mean that we need a few negative CPI reports before we get the easing we need, but then never fully make up for the undershoot. Either that or the Cleveland fed number is just rubbish….economics.

  16. Gravatar of ssumner ssumner
    17. March 2012 at 05:17

    Tom, Maybe, but since we won’t have high inflation, we’ll never know.

    Cthorm, I strongly agree.

    Marcus, Good post.

    Marcus, I am going to offer a challenge to someone. Explain the intuition behind the Cleveland Fed approach. Not the technical stuff, the intuition. Those inflation expectations for 2 and 3 years out seem wildly implausible to me. Where do they get them? Why are they so dramatically different from the TIPS spreads? Why does the Fed itself completely ignore them?

    Marcus, I agree it could mean something else, and that was originally my criticism. But I’m increasingly likely to think it doesn’t ONLY mean that, I think there is an implied promise that has modestly shifted market expectations.

    Bill, You said;

    “I hate the “we need more inflation” notion.”

    Me too! But I can’t analyze Bernanke’s policy without addressing it in his own terms.

    Wonks, Two points:

    1. If we did have a 5% NGDP target, I would pay no attention to the trend in RGDP, and would oppose adjusting the 5% target when trend RGDP growth changed.

    2. However, the Fed doesn’t agree with me. The are (de facto) targeting NGDP at trend RGDP plus 2%.) And that implicit Fed target has now slipped below 4% due to the Great Stagnation. Thus there is no longer a 5% trend line, we are on a new 4% trend. I’d still like to aim for a 4% trend shifted upward vertically, which would in the short run require more than 4% NGDP growth, I’m just saying that 3.5% to 3.8% is probably the new trend line.

    dwb, Looks close to a technical breakout. :)

    Morgan, Use quotation marks.

    Justin, I’m skeptical too. Until someone explains the intuition, I’ll remain skeptical.

  17. Gravatar of Jim Jim
    17. March 2012 at 06:19

    These articles are the beleaguered version of the kind we saw about Greenspan for years, the current political climate now forcing the elite to pass on their accolades only in backhanded and subtle accolades.

    The problem is that we never revisit them after the crap has hit the fan, or none of the current crop of ‘pundits’ would still be around today.

    Without serious and structural reform, we are headed for a much higher cliff than the one in 2008. If nuanced action (if there is any action at all) and speech, implying general denial, is all we can expect from the Fed, then we do not need the Fed and its centralized, artificial stranglehold on monetary policy at all.

    A market in interest rates and competing currencies would do much better at reacting to adversity and preventing bubbles, and the resulting failure of some banks would be much more effective than searching for omniscient regulation.

  18. Gravatar of Expectations of inflation are a “bitch”. What to make of them? | Historinhas Expectations of inflation are a “bitch”. What to make of them? | Historinhas
    17. March 2012 at 19:05

    [...] estimated long term (10 years) inflation expectations. Coincidentally today I read this answer by Scott Sumner to a comment of mine in his blog: Marcus, I am going to offer a challenge to someone. Explain the [...]

  19. Gravatar of Declan Declan
    18. March 2012 at 16:32

    Hey, look on the bright side. At least Lowerstein admits that inflation “will not happen if people think the monetary easing is temporary.”

    I think it is a pretty big deal that a middle-of-the-road journalist is saying that now.

  20. Gravatar of dwb dwb
    23. March 2012 at 12:12

    I am going to offer a challenge to someone. Explain the intuition behind the Cleveland Fed approach. Not the technical stuff, the intuition. Those inflation expectations for 2 and 3 years out seem wildly implausible to me. Where do they get them? Why are they so dramatically different from the TIPS spreads? Why does the Fed itself completely ignore them?

    FWIW I am going to give my take:
    1-forward yields are composed of the actual expected return plus a risk premium (liquidity preference, etc, whatever your favorite name for this is).
    2- there is empirical evidence in the distortion of TIPs yields (tax) vs inflation swaps and survey data.

    In a nutshell they estimate the term risk premium of (1) with volatilities.

    The difference between TIPS yields and cleveland fed estimates is essentially the sum of the estimated risk premium and the TIPS distortion.

    These types of models have a lot of econometric issues and the “risk premium” can vary a lot and, depending on the specification, can be imprecise.

    The way I think of models like this is a 1 data point to add to all the others (big fan of “triangulating” and averaging a bunch of these types of data points). I would neither dismiss it or give it a large weight.

  21. Gravatar of ssumner ssumner
    24. March 2012 at 10:58

    declan, Good point.

    dwb, Thanks, but it’s not obvious to me why a risk premium would reduce the expected yield on TIPS. Are they assuming that people are more worried about high inflation than low inflation?

  22. Gravatar of dwb dwb
    24. March 2012 at 13:11

    it’s not obvious to me why a risk premium would reduce the expected yield on TIPS.

    not exactly. not necessarily high vs low inflation – just uncertainty, period.

    (i am not defending the idea, just stating what i see as the key assumptions )

    my wording maybe was unclear but what i meant was: tips yield = “actual expected inflation” + “risk premium” + “distortion”

    why the risk premium? Forget that we are talking about TIPS for a second. They are basically treating a bond as risky asset, assuming investors are risk-averse, and demand compensation for holding it.

    The risk premium should generally increase with maturity and and volatility (or uncertainty, often measured as the std dev of rates). Put another way, the term structure should slope upward, even if i thought the Fed would be on hold forever, to the extent of the *uncertainty* in my forecasts.

    In other words, since i know far less about the 1 yr rate 9 years from now than the 1 yr rate next year, i should demand a higher yield on the former than the latter, *even if i expected both to be the same*, as an uncertainty premium.

    Assymmetry might play a role, but its a 2nd order effect.

    They are trying to derive the risk premium using some heavy machinery and then back it out (and the “distortion”) from the TIPS yield to arrive at the true “mathematical expectation” of inflation.

    stepping back, thinking about the other meaning of expectations (survey some professional forecasters and take the average) its kinda ironic we have heavy duty model for expecations…

  23. Gravatar of dwb dwb
    27. March 2012 at 17:04

    related to the above, i keep meaning to link to this.

    http://www.econbrowser.com/archives/2012/03/revisiting_the.html

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