Unmitigated gall

Now I’m really angry.  Maybe it comes from studying the Great Depression, and reading all those smug Wall Street types from the 1930s who heaped scorn on the “academic scribblers” who thought deflation was caused by tight money.  The people who thought monetary policy was all about interest rates and credit channels and lending.  As if Zimbabwe wouldn’t have been able to create hyperinflation without a smoothly functioning credit system.  Of course when FDR won he ignored Wall Street and turned to an economist named George Warren, who convinced him that monetary policy wasn’t about banks, it was about determining a path for the price level, for the value of money.  Something our modern Fed has resolutely refused to do, despite a widespread consensus among the world’s best economists (including Bernanke) that we need to set an explicit target, and try to hit that target.

A lot of people, including me, have been critical of Ben Bernanke.  But when you listen to some of the other members of the FOMC, he sounds positively brilliant by comparison.  I already talked about Janet Yellen claiming that monetary policy is ineffective once rates hit zero, despite all sorts of “foolproof” strategies for escaping liquidity traps that have been devised by some of the world’s greatest monetary economists.  And now we have the head of the Dallas Fed claiming that monetary policy is ineffective if the “too big to fail” banks get into trouble.  Thank God FDR didn’t listen to that sort of advice, or a socialist might have been elected in 1936.

The more I see of the other members of the FOMC, the more I wonder if Bernanke could have done a better job even if he had wanted to.  I don’t think he is the most forceful leader; rather he seems more like a typical academic.  In that case we really needed to surround him with 11 other people who were equally brilliant.  People like Mishkin, Mankiw, Hamilton, McCallum, Hall, Svensson, Woodford, and yes, even PAUL KRUGMAN.  Who did, after all, suggest that the Fed needed an explicit inflation target, in the few times he bothered to address the most important issue of the decade—monetary policy.

You might wonder why I mentioned Hamilton.  Didn’t this distinguished economist tell the world that my Cato essay was nonsense?  Actually, compared to the rest of the profession we are almost Siamese twins.  Unlike 90% of the profession we both agree that the Fed should have and could have adopted a more expansionary policy last September.  The main difference is that I think if they had targeted one or two year forward NGDP at 5% growth, near term NGDP would have held up relatively well in the 4th quarter of 2008.  Hamilton is more pessimistic.   But in his blog he was also frustrated with the Fed last year.

Because Dallas Fed President Fisher lectured us all about how it wasn’t the Fed’s fault, those too big to fail banks were to blame, I thought it might be interesting to take a look at whether he was one of the good guys or the bad guys last year.  Was he helping or hurting Bernanke’s efforts to unite the board around a slightly more expansionary policy?  I say this because there were a lot of press reports that there was grumbling within the Fed about Bernanke’s unconventional (and of course ultimately ineffective) policies of injecting interest bearing reserves into the banking system.  So let’s go back to the FOMC vote on August 5, 2008.  You may recall that August was the month when industrial production started plummeting.  In other words the month when an exceedingly mild recession associated with what Arnold Kling correctly calls the “Great Recalculation” turned into a garden variety severe recession, such as occurs any time NGDP falls sharply.  Here is the Fed’s decision to keep rates at 2%:

Votes for this action: Messrs. Bernanke and Geithner, Ms. Duke, Messrs. Kohn, Kroszner, and Mishkin, Ms. Pianalto, Messrs. Plosser, Stern, and Warsh.

Votes against this action: Mr. Fisher.

Mr. Fisher dissented because he favored an increase in the target federal funds rate to help restrain inflation and inflation expectations, which were at risk of drifting higher. While the financial system remained fragile and economic growth was sluggish and could weaken further, he saw a greater risk to the economy from upward pressures on inflation. In his view, businesses had become more inclined to raise prices to pass on the higher costs of imported goods and higher energy costs, the latter of which were well above their levels of late 2007. Accordingly, he supported a policy tightening at this meeting.  (Italics added.)

It was agreed that the next meeting of the Committee would be held on Tuesday, September 16, 2008.

By my reckoning that makes Mr. Fisher the person most responsible for the Fed’s disastrously contractionary policy of last year, which reduced NGDP at the fastest rate since 1938, and, along with the ECB and BOJ, drove the world into a deep recession.  Not only did this policy cost millions of jobs in this country, but tens of millions in developing countries where people have absolutely no safety net.

I’m as much of an inflation hawk as the next guy, but the markets were far more worried about recession than inflation last August.  And in September, when Mr. Fisher refused to recommend any easing, the markets were actually concerned that both inflation and output would come in far below Fed targets.  I remember the 1970s too.  But weren’t T-bill yields in the late 1970s around 15%, not around 1%?  Where is this inflation that right-wingers keep saying is just around the corner?  And worst of all, he doesn’t seem to realize that if the banking system really was that crucial, perhaps the Fed shouldn’t have been be flirting with a liquidity trap, as we all saw what happened to Japanese banks when prices started falling.

Some people might ask whether I am being too hard on Mr. Fisher.  I don’t doubt he is a great guy who made the best decision he could.  [You're probably saying "Too late to equivocate Sumner, you've already blown any chance at a job at the Dallas Fed."]  I suppose we have to look at the system.  For instance, let’s suppose these errors were in good faith.  There wasn’t enough evidence in August to ease.  There wasn’t enough evidence in September to ease.  And in October, suddenly it was too late to ease?  Suddenly the economy was so far gone that only fiscal policy could save us?  How does something like that happen?  I thought the economy was like a big ocean liner that changed course slowly.  I really don’t believe this excuse.  But let’s say it’s true for the sake of argument.  One meeting no easing is necessay, the next meeting it’s too late to ease.  If true, shouldn’t the FOMC be meeting, like, every %$&#@&% day?


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10 Responses to “Unmitigated gall”

  1. Gravatar of marcus nunes marcus nunes
    29. September 2009 at 02:25

    It wasn´t even at the next meeting. It was 3 weeks later, on October 8 that the Fed (and the ECB and the BoJ) brought rates down in a coordinated action. That week the S&P dropped 18%!

  2. Gravatar of ssumner ssumner
    29. September 2009 at 06:23

    marcus, That’s right. That’s what I meant, the meeting after September, not August.

  3. Gravatar of StatsGuy StatsGuy
    29. September 2009 at 11:01

    Hmm, tried a longish post a couple of times, but it got eaten by the blog daemons. But the blog still thinks it’s there… Could by why the number of comments here is this today.

  4. Gravatar of Current Current
    29. September 2009 at 11:29

    There are strange things going on in blogdom. I think that blogger and wordpress have updated the comment filtering parts of their code to try to remove more spambot posts and attacks. I think it’s affecting other things too.

    Everything that I’ve written to MoneyIllusion recently has been posted. But on several other sites my posts have been disappearing into bit heaven.

    I’ve also noticed that in the sidebar of this site all of my posts come up, but some other folks posts don’t always appear.

  5. Gravatar of ssumner ssumner
    29. September 2009 at 15:21

    statsguy and current. It’s weird, I never see the problems with my blog, even from hotel computers. I don’t know what others are seeing. Is it still the Cialis ads?

  6. Gravatar of Mike Sandifer Mike Sandifer
    29. September 2009 at 17:28

    As someone new to such considerations, I have noticed that no one I’ve heard who opined on the subject agrees with the Fed’s approach to this crisis.

    The of NGDP targeting seems so simple and elegant.

  7. Gravatar of StatsGuy StatsGuy
    30. September 2009 at 04:10

    [Breaking this into pieces]

    This is consistent with the story that the Fed was overly concerned with dollar valuation at that time. Fisher’s statements seem to reflect a belief that commodity inflation (especially oil, which is excluded from core inflation), would permeate into core inflation via pass-through into consumer prices. Indeed, consumer package goods prices were already starting to rise as manufacturers rediscovered pricing power, and this could have become a problem IF the commodity prices had persisted at that level for much longer. But Fisher didn’t seem to trust the markets to self-correct – by the time he acted, demand destruction in oil had already set. [Oil had already started it’s rapid fall from >140 to <40 in a single quarter; by August 08, storage facilities were already starting to fill up. Fisher seemed to believe the oil price was a long term persistent phenomenon, but then again, so did the markets unless you believe the prices resulted from irrational speculation or manipulation.]

  8. Gravatar of StatsGuy StatsGuy
    30. September 2009 at 04:13

    [piece 2]

    Fisher has a legitimate concern in a broader sense – but he suffered from a lack of mental agility. His worldview that prevented him from seeing evidence of commodity and asset price collapses, and of anticipating the impact of asset price collapses on banks. In that essay, Fisher is STILL obsessed with the credit channel narrative as the primary explanation for the collapse.

    What caused the collapse? According to Fisher, it was the Evil Blob.

    He STILL has the causation (mostly) backwards, believing that an “exogenous” shock to credit channels caused the AD collapse. And _some_ of this surely happened (as Hamilton noted). But he’s missing the causation from the anticipated (and later real) AD collapse to the credit channels and demand for credit. I would argue that loan rates WERE nominally low at that time (which is what most people consider when buying a house). But loans were only available to those with good credit and lots of collateral. Fisher focuses on the “no one is lending” story (which had some validity in the short term corporate paper market) but utterly forgot the broader “no one (with good credit) is borrowing” story.

    The failure of the central bankers was a cognitive failure – they were locked into a paradigm that caused them to misinterpret existing evidence in a way that is consistent with their current narrative of how the world operates. (Many international relations scholars have argued this is how some wars get started – e.g. Robert Jervis and “Misperception Theory”.)

  9. Gravatar of StatsGuy StatsGuy
    30. September 2009 at 04:18

    Closing Comment:

    If Fisher conducted his daily life like he conducts Fed policy, he would walk through his life facing backwards.

  10. Gravatar of Scott Sumner Scott Sumner
    1. October 2009 at 09:48

    Mike and Statsguy, I see Mike’s comment as relating to statsguys’ first comment. the only way I can make sense of Fisher’s approach is to assume he cares only about inflation, not real growtth. Of course he is legally bound to care about real growth. That’s why I favor NGDP targeting, one is less likely to miscalculate so badly as he did in August and September 2008. It also shows the need for forward-looking policy. And some common sense–is a financial crisis caused by falling asset values the best time to instill an anti-inflationary policy?

    Statsguy#2, Again, I strongly agree with your points. I would just add than one reason loan rates were low was that asset prices were falling. But I agree that the limits on credit availability also played a role in falling AD.

    Statsguy#3, And it’s not just Fisher. I use the metaphor of driving a car while looking through the rear view morror.

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