Woodford on the Fed’s new guidance

The Washington Post got these comments from Michael Woodford:

As I’ve discussed before, I think there are important advantages of clarifying the criteria that will determine likely future policy. Today’s statement provides important additional clarification of the conditions under which it will be appropriate to begin raising short-term interest rates, relative to the FOMC’s statements in September and October. Such clarification is particularly likely to help stimulate the economy when, as in this case, it indicates that the conditions required for policy tightening will not be reached as early as some might have expected on the basis of past Fed behavior.

The explicit thresholds mentioned today are not ones that will be reached as soon as a federal funds rate above 25 basis points would be dictated by a reaction function estimated on the basis of the FOMC’s pre-crisis decisions, and in that respect the announcement should change the forecasts of future Fed policy of at least some market participants.

A more explicit discussion should also reduce some of the considerable uncertainty about Fed policy that has resulted from the series of unprecedented actions taken over the past few years. While the quantitative thresholds announced are not the ones that I have advocated, they represent a substantial improvement upon the date-based approach to forward guidance that continued to be used in the September and October FOMC statements.

The statement also clarifies that the federal funds rate target will remain low even after the asset purchase program ends; this has the advantage of allowing that program to end without the FOMC having to fear that this would be taken as a signal that interest-rate increases are also imminent. While there are no plans to end the asset purchases soon, I think it is important that the FOMC not be boxed in to a continuation of asset purchases at the current rate for as many years as might be needed to reach the thresholds required to justify raising short-term interest rates.

Some people have wondered why the stock market reaction was so muted.  I think Woodford provides two reasons here.  The guidance wasn’t as aggressive as he would have liked, and it was already close to what the markets expected.  Woodford would have preferred something more aggressive, i.e. something that would lead to greater than 5% NGDP growth.  In my view this policy is probably expected to lead to 4% to 5% NGDP growth.

PS.  Also over at the WaPo, Brad Plumer has a good article about how there is increasing global momentum toward more monetary stimulus.

PPS.  Readers than are fluent in French might wish to take a look at this paper by market monetarist Nicolas Goetzmann.


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44 Responses to “Woodford on the Fed’s new guidance”

  1. Gravatar of marcus nunes marcus nunes
    13. December 2012 at 09:01

    Scott
    The WAPO also describes a “paralell universe” where Bernanke for the past five years has shown aggressiveness and creativity, among other things:
    http://thefaintofheart.wordpress.com/2012/12/13/meanwhile-in-a-parallel-universe/

  2. Gravatar of Bill Woolsey Bill Woolsey
    13. December 2012 at 09:29

    Marcus:

    Bernanke has been very creative and aggressive in “fixing” credit markets. He has tried all sorts of things to rebuild the shadow banking house of cards along with making sure that money center commercial banks continue to pay all of their creditors.

    Oh, you meant being creative and aggressive in preventing and reversing the imbalance between the quantity of money and the demand to hold money and the consequent decrease in spending on output.

  3. Gravatar of Saturos Saturos
    13. December 2012 at 09:41

    Bad time to take a break from the internet. Very bad timing. D’oh!!

  4. Gravatar of Saturos Saturos
    13. December 2012 at 09:43

    Here are Larry Ball’s comments: http://gregmankiw.blogspot.com.au/2012/12/interpreting-fed.html

  5. Gravatar of Saturos Saturos
    13. December 2012 at 09:46

    Yes I know, mainstream economists are in fairyland thinking that the neutral rate of interest is still positive. This is why I hate Taylor rules.

  6. Gravatar of Evan Soltas Evan Soltas
    13. December 2012 at 09:52

    If widely desired, I could translate this. (I’m volunteering conditional on the demand.) But I imagine Google Translate could do the job well enough.

  7. Gravatar of Saturos Saturos
    13. December 2012 at 09:57

    “It is not clear whether the Fed’s announcement of future dovishness will have significant effects today. The efficacy of announcements about future monetary policy is unproven.”
    - Laurence Ball, top macroeconomist

    It’s like he doesn’t read Woodford at all…

  8. Gravatar of Mike Sax Mike Sax
    13. December 2012 at 09:57

    Greg Sargent has his own interpretation of the Fed’s move: a victory for liberal economics

    http://diaryofarepublicanhater.blogspot.com/2012/12/greg-sargent-declares-feds-evans-rule.html

  9. Gravatar of Saturos Saturos
    13. December 2012 at 09:58

    Evan, I desire it.

  10. Gravatar of Saturos Saturos
    13. December 2012 at 09:59

    Mike, yes, only a liberal could support the end of repressively tight monetary conditions engineered by a meddling central bank throwing millions out of work. Obviously.

  11. Gravatar of Tom Hannaford Tom Hannaford
    13. December 2012 at 10:07

    I suppose one could label it a victory for “liberal economics”, although to confuse that with a victory for “left wing economics” seems odd at best. I’d venture to say many of the economists who are at least somewhat supportive of the fed’s new direction (even if they dislike the idea of a central bank in the first place) are not exactly the biggest fans of the American left that Sargent is declaring victory for…

  12. Gravatar of Federico Federico
    13. December 2012 at 10:11

    (Not related to this post)

    Krugman says that the Fed’s actions weren’t that big of a deal because rates actually rose (http://krugman.blogs.nytimes.com/2012/12/13/bernankes-non-stupidity-pact/) suggesting that Krugman thinks that when rates fall it represents positive expectations for the economy. To be fair, he does talk about expected inflation afterwards in a way that hints that he does understand how market prices should react to credible steering of nominal spending by the Fed. That being said, it’s very frustrating to see market watchers judge the efficacy of Fed policy by how much it drives down nominal rates. It would be enlightening for everybody if you wrote another post about this fallacy. I know you’ve done so in the past, but the idea still doesn’t appear to be well understood (and lately your posts have been attracting more attention than usual, so perhaps you’ll spark a wider conversation through the blogosphere)

  13. Gravatar of ssumner ssumner
    13. December 2012 at 10:13

    Marcus and Bill, I agree.

    Saturos, We think alike. In another thread I just argued fthe Taylor rule is dead, and will remain dead going forward.

    Evan, Why am I not surprised you know French as well. Seriously, don’t feel a need to translate it, but let us know if there’s something especially distinctive that we should take a look at. Once the semester (grading) is over I’ll take a look with Google translate.

    Mike Sax, Who were the first people to demand monetary stimulus back in 2008-09?

    Next you’ll be telling us that Milton Friedman was actually a liberal. (Actually he was–a classical liberal, and so am I.)

    I’ve heard of Tom Sargent, but who is Greg Sargent?

  14. Gravatar of Laurent Laurent
    13. December 2012 at 10:41

    The part on the immorality of price stability in the Nicolas Goetzmann paper is somewhat surprising to read. How does one deal with 1970′s like natural resources shock in such an economic and moral framework?

  15. Gravatar of Mike Sax Mike Sax
    13. December 2012 at 10:42

    Scott now wait a minute. I wasn’t telling you anything. I was simply quoting Sargent. Not every time I quote someone means I advocate their position. I did find it interesting though and figured you’d appreciate it! LOL

  16. Gravatar of Mike Sax Mike Sax
    13. December 2012 at 10:43

    “Mike, yes, only a liberal could support the end of repressively tight monetary conditions engineered by a meddling central bank throwing millions out of work. Obviously.

    Saturos I will point out though that it is true that those most in favor of repressive tight monetary conditions the last 3 years are the conservative Republicans. How many tight money bills have there been?

  17. Gravatar of StatsGuy StatsGuy
    13. December 2012 at 11:09

    @ Saturos

    “Yes I know, mainstream economists are in fairyland thinking that the neutral rate of interest is still positive.”

    Oh, that’s not the only fairyland story they believe. This quote from the Liborgate investigation:

    Alan Greenspan:

    “Through all of my experience, what I never contemplated was that there were bankers who would purposely misrepresent facts to banking authorities,” Alan Greenspan, chairman of the U.S. Federal Reserve from 1987 to 2006, said in a phone interview. “You were honor-bound to report accurately, and it never entered my mind that, aside from a fringe element, it would be otherwise. I was wrong.”

    HUGE sums of money involved in subjectively reported numbers with tiny decimals and no regulators conducting oversight, and it NEVER entered his mind that anyone would distort the truth.

    http://www.bloomberg.com/news/2012-12-13/rigged-libor-with-police-nearby-shows-flaw-of-light-touch.html

    Fairytales… Because, you know, incentives don’t really matter.

  18. Gravatar of Major_Freedom Major_Freedom
    13. December 2012 at 11:19

    ssumner:

    Who were the first people to demand monetary stimulus back in 2008-09?

    The same people who demanded monetary stimulus throughout the 1990s and 2000s, that blew up another bubble and made exponentially higher doses of Fed inflation perceived as necessary to solve the “inexplicable” demand shock of 2008?

    Where is the MM explanation of why, given that the Fed was not burning money, did nominal demand suddenly fall, such that an even higher inflation from the Fed was necessary to coax more spending out of people to sustain the prevailing cost structure? Why was the prevailing inflation so incredibly insufficient to maintain at least the same spending as before?

    Since it obviously wasn’t because people wanted to hold more money to sit on forever after, the problem must have necessarily been on the “real side” of the economy that lead to such increased demand for money.

  19. Gravatar of ChacoKevy ChacoKevy
    13. December 2012 at 11:40

    @Evan,
    If you do translate, will you start from scratch? I’ve found google translate to be so good that I simply plug in the text and peruse it for edits. Much faster than translating myself word for word.
    I work with Spanish, though, so I suppose it’s possible that google has shown it more attention than other languages.

  20. Gravatar of Patrick R. Sullivan Patrick R. Sullivan
    13. December 2012 at 12:00

    ‘“Through all of my experience, what I never contemplated was that there were bankers who would purposely misrepresent facts to banking authorities,”’

    I wonder if Greenspan ever thought the monetary authorities would call bankers and encourage them to misrepresent interest rates. Which is what seems to have happened with Barclays’

  21. Gravatar of TravisAllison TravisAllison
    13. December 2012 at 12:22

    Scott, can you explain the disconnect between the bond and stock markets? Your explanation for the stock market’s muted reaction contradicts the bond market’s big move. I think the stock market is falling because of fiscal cliff concerns and Bernanke’s reiteration that he can’t do much. I am not sure why the bond yields would rise, unless it is connected to fear of the debt ceiling and default. The latter seems doubtful, because why would default suddenly leap to the forefront of concerns on FOMC day and the day after?

  22. Gravatar of Major_Freedom Major_Freedom
    13. December 2012 at 14:21

    Where is the discussion of additional inflation leading to additional risk and financial fragility?

  23. Gravatar of Tyler Joyner Tyler Joyner
    13. December 2012 at 14:37

    Travis – This isn’t intended as criticism of Scott, or any other economist, but if they could predict the markets there would be more economists who were also billionaire hedge fund CEOs. Now ask yourself what the difference between a prediction and an ex post facto explanation is.

    That being said, Scott has said before that increased inflation expectations would lead to rising bond yields as the necessary yield for any certain level of risk increases. I don’t think many people would disagree that inflation expectations are one factor in bond yields.

  24. Gravatar of Cthorm Cthorm
    13. December 2012 at 14:38

    From Goetzmann:

    ” It proposes to review the tasks entrusted to the European Central Bank, which he said would reconsider its action.”
    +1

    The rest is in a PDF format which makes using Google Translate a little more difficult.

  25. Gravatar of Gregor Bush Gregor Bush
    13. December 2012 at 14:54

    Scott,
    Since I’m disagreeing with you, Woodford, Krugman and the market I’m almost certainly wrong but I’m actually quite encouraged. I see no reason why the Fed is done easing. And what they did yesterday was put in place a framework that will allow them to do so more effectively next year when the makeup of the board is more dovish.

    Now that the Fed has these thresholds, there’s nothing to stop them from linking them to further asset purchases or IOR cuts as well. And that’s really all that’s missing now. If the Fed made it clear that a UR rate decline of 0.5% and inflation of 1.8% in the first half of the year was still weak enough to engender ACCELERATED purchases, we’d be off to the races.

    Also, a two-year ahead inflation forecast of 2.5% is actually quite high when you consider that the Fed using a Phillips-curve model to forecast inflation. So the real threshold is core inflation well above 3%.

    When I read the statement my first instinct is to get out of cash and Treasuries and into US real estate. The US will not be Japan.

  26. Gravatar of Benjamin Cole Benjamin Cole
    13. December 2012 at 17:23

    Gotta say, I love the QE, think it should be bigger and growing until positive effects realized.

    The guidance? Like it, think it means little.

    Most people could not pick Bernanke out of lineup of NBA all-stars.

    Besides, credibility is something public officials not not have, no matter how much they talk about it, how high their epaulets, no matter how many flags are flying on the podium.

    Business hire when they see demand. They do not look to the Fed for direction.

    So print a tidal wave of money. People understand that.

    They understand packed bars full of big tippers, car dealerships where you have to wait to get your model, packed lots at the malls, lots of home buying.

    Without the real boom times, Bernanke could put on military fatigues and no one would care.

    People just do not understand the Fed—-not too surprising, since the econ profession has argued for an independent and even opaque and secretive Fed for many a moon.

  27. Gravatar of Doug M Doug M
    13. December 2012 at 18:20

    The stock market reaction was muted, because the Fed gave exactly what the fed was expected to give. They had already telegraphed $45B/month purchase program, and the guidance piece of it was a bit of a yawn, too.

  28. Gravatar of Doug M Doug M
    13. December 2012 at 18:23

    Who were the first people to demand monetary stimulus back in 2008-09?

    You would have been too late… who were the people demanding stimulus in 2007 — lots of people were…Toxic debt was crushing Wall Street by the middle of 2007.

    As I remember Caroline Baum was calling on the Fed to start cutting rates as early as 2006.

  29. Gravatar of Saturos Saturos
    13. December 2012 at 18:40

    Here is Mike Konczal’s piece: https://prospect.org/article/federal-reserve-gets-down-business

  30. Gravatar of Saturos Saturos
    13. December 2012 at 19:36

    Here is Matt O’Brien’s piece: http://www.theatlantic.com/business/archive/2012/12/the-man-who-occupied-the-fed-how-charles-evans-saved-the-recovery/266183/

    And Ryan Avent has the best explanation of the muted reaction: http://www.economist.com/blogs/freeexchange/2012/12/monetary-policy-2
    In other words the Fed still isn’t actually targeting the forecast.

  31. Gravatar of Saturos Saturos
    13. December 2012 at 19:38

    And Mario Draghi is Person of the Year, according to the FT: http://www.businessinsider.com/mario-draghis-ft-person-of-the-year-2012-12

  32. Gravatar of Saturos Saturos
    13. December 2012 at 19:40

    Evans seems to have emerged as some sort of a liberal hero, suggests the Twittersphere.

  33. Gravatar of dtoh dtoh
    13. December 2012 at 19:43

    I don’t know why there is a continued focus on the Fed Funds Rate. This is entirely meaningless especially since it refers only to the nominal rate. What matters is the real rate (real financial asset prices) not the nominal rate.

    On top of that, even if you focus on the real rate, the appropriate rate depends on expectations or more specifically whether the the indifference curve between holding financial assets versus spending on real goods and services has shifted. Depending on expectations, a much higher rate could be entirely consistent with a more expansionary monetary policy.

  34. Gravatar of Saturos Saturos
    13. December 2012 at 20:06

    Actually on second thought seems like they are targeting the forecast. It’s just not a very sensible forecast. Of course the real problem is how they are splitting up their projections of real growth and inflation into separate variables… it would be a mistake to infer a 5% NGDP growth target from the figures they are providing, it doesn’t necessarily sum that way. They are mixing up things they do really control and can credibly target and tie forecasts of to their own behavior, and things they don’t.

  35. Gravatar of Saturos Saturos
    13. December 2012 at 20:13

    Scott, do you agree with the characterization of TIPS as Terribly Illiquid Pieces of $#!%?

  36. Gravatar of Saturos Saturos
    13. December 2012 at 20:46

    Felix Salmon’s Economic Model: http://blogs.reuters.com/felix-salmon/2012/12/12/a-big-red-dog-explains-the-fiscal-cliff/

  37. Gravatar of Michael Michael
    14. December 2012 at 03:50

    Evans, Kocherlakota, Plosser discuss monetary policy at UChicago:

    http://news.uchicago.edu/article/2012/12/13/fed-presidents-discuss-economic-recovery-becker-friedman-institute

    “Asked about the prospect of the Fed adopting a target for nominal gross domestic product growth, Evans said he would favor something like that for its signaling value to markets and households, but thinks use of such a tool lies in the future.

    Kocherlakota thought it would be challenging to set a correct path for economic output. “I don’t think of nominal GDP targeting as congruent with dual mandate we’ve been set by Congress,” he added. Plosser agreed, noting that setting such a target suggests indifference about how much growth comes from inflation and unemployment. “I don’t think we’re indifferent.””

  38. Gravatar of dtoh dtoh
    14. December 2012 at 04:12

    dtoh

    Kocherlakota thought it would be challenging to set a correct path for economic output. “I don’t think of nominal GDP targeting as congruent with dual mandate we’ve been set by Congress,” he added. Plosser agreed, noting that setting such a target suggests indifference about how much growth comes from inflation and unemployment. “I don’t think we’re indifferent.”

    Could someone please tell me how for a given NGDP growth rate, monetary policy can have any impact on the mix between RGDP and inflation. If anyone believes this is possible, please state the mechanism by which this would work.

    Kocherlakota also said that they expect to continue paying interest on bank’s excess reserves, noting that this will be a useful tool if inflation rises and the Fed needs to reverse current policy.

    To my way to thinking that’s incredible convoluted thinking. It’s like saying “I think I’ll use my fire extinguisher now in case I have a fire in the future.”

  39. Gravatar of Michael Michael
    14. December 2012 at 05:04

    dtoh, isn’t that exactly Kocherlakota’s point? That an NGDP target would not address the balance between inflation and growth, thus inflation targeting is better?

    It’s interesting to see where his “hang up” is.

  40. Gravatar of Benjamin Cole Benjamin Cole
    14. December 2012 at 05:34

    DTOH:

    I agree. Monetary policy can boost nominal demand.

  41. Gravatar of Bill Woolsey Bill Woolsey
    14. December 2012 at 06:26

    Is Plosser making a point about an objective function?

    Mr. Engineer is saying that nominal GDP suggests that deviations of real output from target are given an equal weight in the social welfare function as deviations of inflation from target?

    “We’re not indifferent?”

    Market Monetarists believe that there is a natural negative correlation between “supply-side” shocks to potential output and the price level. From our perspective, a target for inflation that interferes with those price level changes is bad. It isn’t reducing a loss in social welfare due to inflation. It is causing a loss of social welfare. In my view, anyway, real output should shift with changes in potential output. It is output gaps that are to be avoided.

    The problem, then, with nominal GDP level targeting is that natural shifts in the price level and potential output are unlikely to have a correlation of -1 at all times.

    But if we don’t have good real time measures of potential output, or even very good measures of potential output, then coming up with some objective function that assumes this is known is absurd.

    And, by the way, I don’t favor letting Plosser determine social welfare tradeoffs anyway.

    I think nominal GDP level targeting is better than other realistic alternatives.

    Maximizing social welfare assuming knowledge of potential output is not a realistic alternative.

    I think a strict inflation target is a realistic alternative (and I think Plosser favors that.) Nominal GDP level targeting is much better than his alternative.

  42. Gravatar of dtoh dtoh
    14. December 2012 at 08:49

    I don’t think monetary policy has any significant impact on the balance between real growth and inflation. If you have 5% NGDP growth, then you will i% inflation and r% real growth, and conversely if you have i% inflation then you will have r% real growth and 5% NGDP growth. Monetary policy has little or no ability to shift the balance. You can shift the ratio of i to r by changing the NGDP target (e.g. higher NGDP will result in a higher ratio of i to r, but at any given NGDP growth level you’re basically stuck with a fixed ratio. Other things may affect the ratio but not monetary policy.

    The Fed may not be indifferent, but they are certainly impotent and for Kocherlakota to suggest otherwise is just plain wrong.

    That said, I do think the Fed can impact the ratio in the short run depending on how fast they try to get back to the level target. If they boost AD demand too quickly, it can cause short term supply effects that will result in short term inflation (a la 1933), but that has nothing to do with which target they use or what level they set the target at, it’s only a function of how quick they want to get to the target…. and that problem exists whether you target inflation or NGDP.

  43. Gravatar of ssumner ssumner
    14. December 2012 at 14:53

    Mike Sax, Glad to hear you don’t agree with the moronic quotes you often post here. It will save me time not having to respond to them in the future.

  44. Gravatar of ssumner ssumner
    14. December 2012 at 20:21

    Travis Allison, What big move in the bond market?

    Saturos, TIPS are highly liquid–the bid-asked spread is tiny.

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