Kocherlakota is almost there—just needs to drop the word “too”

Johnleemk and Nic Johnson sent me this great quotation from Minneapolis Fed president Narayana Kocherlakota.

[The Fed] has also been targeting a fed funds rate of under a quarter percent for nearly four years—and anticipates continuing to do so through mid-2015. In the language of central banking, the Fed’s policy stance is considerably more accommodative than it was five years ago. . . .

Some observers argue that the Fed has done too much, has been too accommodative. I strongly disagree. … In light of the unusually large macroeconomic shock, I believe that it is misleading to assess the FOMC’s actions by comparing its current choices to policy steps taken over the past 30 years. Instead, we have to assess monetary policy by comparing the economy’s performance relative to the FOMC’s goals of price stability and maximum employment. In particular, if the FOMC’s policy is too accommodative, that should manifest itself in inflation above the Fed’s target of 2 percent. This has not been true over the past year: Personal consumption expenditure inflation—including food and energy—is running closer to 1.5 percent than the Fed’s target of 2 percent.

But this comparison using inflation over the past year is at best incomplete. Current monetary policy is typically thought to affect inflation with a one- to two-year lag. This means that we should always judge the appropriateness of current monetary policy using our best possible forecast of inflation, not current inflation. Along those lines, most FOMC participants expect that inflation will remain at or below 2 percent over the next one to two years. Given how high unemployment is expected to remain over the next few years, these inflation forecasts suggest that monetary policy is, if anything, too tight, not too easy.  (Bold print added by Johnleemk.)

It’s really gratifying to see Fed people like Dudley and Kocherlakota getting closer and closer to the truth, that Fed policy has been ultra-tight since mid-2008, just as Fed policy in the 1930s was ultra-tight, despite near-zero interest rates.  Over time, people will stop talking about policy as being “too tight” and just start calling it “tight,” as Friedman did in 1997 when Japanese policy was too tight to hit their inflation target, and interest rates were near-zero.  After all, you rarely see people say; “Those 1000% interest rates show that monetary policy was tight during the German hyperinflation, albeit too expansionary relative to the needs of the economy.”  They simply cut to the chase. Policy was too easy!

When I started out in late 2008 and early 2009 my claims that tight money was the problem were met with incredulous stares.  Now we’ll see who gets the last laugh.  Indeed (here’s a teaser) we may find that a month from now I’ll be able to get the last laugh on some of my early critics.  I have a long memory.

I’ll get back to the MOE/MOA debate tonight.

PS.  Do you see a bit of sarcasm when an academic says “in the language of central banking.”


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20 Responses to “Kocherlakota is almost there—just needs to drop the word “too””

  1. Gravatar of Morgan Warstler Morgan Warstler
    31. October 2012 at 06:41

    A week from now we should know which of us is the dominant paradigm.

    Big bets are fun, but I’m ready with either speech.

    For your own sake, cross your fingers for Obama, because if Mitt Romney wins, I will be a total nightmare.

  2. Gravatar of Patrick R. Sullivan Patrick R. Sullivan
    31. October 2012 at 07:43

    Veni, vidi, vici.

  3. Gravatar of Bonnie Bonnie
    31. October 2012 at 09:23

    “Given how high unemployment is expected to remain over the next few years, these inflation forecasts suggest that monetary policy is, if anything, too tight, not too easy. ”

    It’s a step in the right direction… maybe. It might mean that he is now more interested in actually hitting the inflation target, which is a plus, but still inadequate unless undershooting is addressed.

  4. Gravatar of Major_Freedom Major_Freedom
    31. October 2012 at 09:25

    When I started out in late 2008 and early 2009 my claims that tight money was the problem were met with incredulous stares. Now we’ll see who gets the last laugh. Indeed (here’s a teaser) we may find that a month from now I’ll be able to get the last laugh on some of my early critics. I have a long memory.

    I really don’t understand this. What does the notion of certain Fed employees, like Kocherlacota, adopting one or another IDEA concerning money and whether it is “tight” or “loose”, have to do with whether or not money actually IS “tight” or “loose”?

    It’s like my neighbor Frank trying to convince his credulous son that the world is 6000 years old. Then, after his constant badgering seems to be working, and his son seems to be agreeing with it, Frank says “Haha, who has the last laugh now you geologists! Little Billy is starting to come around to the truth! This is so gratifying. Take THAT!”

    Uh, well, OK, sure, if THAT is your standard.

  5. Gravatar of marcus nunes marcus nunes
    31. October 2012 at 10:43

    “The truth shall set you free”

  6. Gravatar of ChargerCarl ChargerCarl
    31. October 2012 at 11:38

    Does the FED actually have a 2% inflation target written in stone or something? I thought their mandate was stable/low inflation and high employment and the 2% figure was just where the mandate ended up meeting.

  7. Gravatar of Lars Christensen Lars Christensen
    31. October 2012 at 12:56

    Scott, this is incredible. Kocherlakota deserves a lot of credit. He has changed his mind. He has learned. Few central bankers are willing to learn. Kocherlakota has changed his mind about US monetary policy. This makes me a lot more optimistic about the outlook for the US economy. I wish we had that kind of central bankers in Europe.

  8. Gravatar of Narayana – this might be love « The Market Monetarist Narayana – this might be love « The Market Monetarist
    31. October 2012 at 13:51

    [...] Scott Sumner also comments on Kocherlakota. Share this:Email Pin ItLike this:LikeBe the first to like this. Leave a Comment by Lars [...]

  9. Gravatar of Max Max
    31. October 2012 at 14:49

    Inflation slightly below target doesn’t mean that monetary policy is “ultra tight”. It’s not even a problem in itself, any more than slightly above target inflation is a problem.

    What is a problem is the lingering output gap, which the Fed is supposed to care about (the dual mandate). And probably does care about, but not to the extent of being willing to take unorthodox steps.

  10. Gravatar of Don Geddis Don Geddis
    31. October 2012 at 15:43

    ChargerCarl: 2% is not a dual-mandate compromise. Central banks could choose almost any number as their inflation target, and (long term) employment will eventually adjust.

  11. Gravatar of JimP JimP
    31. October 2012 at 16:37

    Lars

    And this should give a lot of credits to Bernanke. I have said harsh things about Bernanke on this blog and I now see that I was wrong. This process of educating Kocherlakota and presumably other board members as well meant Bernanke had to move slowly – and so he did. These ideas have a firm base on the Fed board and one can presume that if Romney wins, and I for one hope that he does not, but if he does the deflationists will have a harder time than they think.

    And if I were Bernanke I would resign both the Chairmanship and the Fed board the day of Romney’s inauguration – as I surely cannot imagine working for a guy who has said things about me like the plastic mind of Romney has said or implied about Bernanke.

    Of course, Romney is now taking everything he ever said about anything back. And anyone who believes him – I will sell you any bridge in New York not currently under water.

  12. Gravatar of JimP JimP
    31. October 2012 at 16:40

    Or – rather than resign – I hope Bernanke stays on the Fed as Chairman and fights the deflationists tooth and nail. That would be much better.

  13. Gravatar of From “hero” to “nemesis” in 2 short years | Historinhas From “hero” to “nemesis” in 2 short years | Historinhas
    31. October 2012 at 17:13

    [...] for him, Kocherlakota will not be “homeless” for long. Fallen Idol for some, Born Again Hero for others! Rate this:Share this:EmailTwitterLike this:LikeBe the first to like this. This [...]

  14. Gravatar of Gene Callahan Gene Callahan
    31. October 2012 at 18:28

    @Morgan: I think you meant, “if Mitt Romney wins, IT will be a total nightmare.”

  15. Gravatar of Fed Up Fed Up
    31. October 2012 at 19:28

    “In particular, if the FOMC’s policy is too accommodative, that should manifest itself in inflation above the Fed’s target of 2 percent. This has not been true over the past year: Personal consumption expenditure inflation—including food and energy—is running closer to 1.5 percent than the Fed’s target of 2 percent.”

    Try using the price inflation rate of a lower/middle class person’s budget. See if it is below 2%. I’m guessing it is at least 1% above 2%, probably 2% or 3% above 2%.

  16. Gravatar of Tim Tim
    31. October 2012 at 21:10

    Hi Scott
    Haven’t you said in the past though that monetary policy affects AD with long and variable leads, not lags?

  17. Gravatar of Lars Christensen Lars Christensen
    1. November 2012 at 01:03

    JimP, I think you are right. Or rather Bernanke now finally have come to realize that he needs to educate his colleagues. It has taken a long time. But I also think Bernanke has been educated in the process – haven’t we all?

  18. Gravatar of Saturos Saturos
    1. November 2012 at 02:55

    Fed Up, the purpose of inflation targeting is not to lower the cost of living of a lower/middle class person, or anyone else for that matter.

    The real problem is that the public thinks exactly like FedUp. Bernanke can only do so much under such a popular regime. (Scott’s beloved democracy.) Or unless a deus ex machina imposes NGDPLT.

  19. Gravatar of ssumner ssumner
    1. November 2012 at 05:08

    Tim, Yes.

  20. Gravatar of Saturos Saturos
    1. November 2012 at 05:45

    Tyler has some very good comments on evaluating fiscal policy: http://marginalrevolution.com/marginalrevolution/2012/11/cyclically-adjusted-measures-of-the-stance-of-fiscal-policy.html

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