I was in a bad mood when I wrote my last post on Mr. Fisher. I turned 54 that day and would have rather been spending the time with my family. This is another foul-tempered post. But don’t worry it’s (relatively) short, and I’ll do one soon on the thinking man’s sex symbol (Scarlett Johansson.)
Mr. Fisher is in the news again. I know you guys don’t like me to refer to last year’s monetary policy as “tight,” so let’s just call it much less expansionary than needed to prevent a severe downturn. And Mr. Fisher was the most aggressive opponent of greater monetary ease. Now with unemployment expected to rise to over 10% next year, he sounds like he can hardly wait to raise interest rates:
WASHINGTON (AP) — To prevent inflation from taking off, the Federal Reserve will need to start boosting interest rates quickly and aggressively once the U.S. economy is back on firmer footing, a Fed official warned Tuesday.
“I expect that when it comes time to tighten monetary policy, my colleagues and I will move with an alacrity that, if needed, will be equal in speed and intensity” to when the Fed was slashing rates to battle the recession and the financial crisis, said Richard Fisher, president of the Federal Reserve Bank of Dallas.
At first the second sentence sounded scary, but then I recalled that the Fed did not raise rates once between May 1st and early October, 2008, the period when the world economy was falling off a cliff. So perhaps if they move with equal “speed and intensity” it won’t be so bad. But the next sentence indicates that it isn’t just Mr. Fisher:
Although Fisher has a reputation for being one of the Fed’s toughest inflation fighters, it marked the second such warning by a central bank official in recent days. Fed member Kevin Warsh on Friday said the central bank will need to move swiftly when the time comes to raise rates.
You might ask what’s so unreasonable about their views; after all don’t we need to tighten at some point to prevent a breakout of inflation? Yes, but there are still two very serious problems with what Fed officials are saying:
“The wind-down process needs to begin as soon as there are convincing signs that economic growth is gaining traction and that the lending capacity of the banking system is capable of expansion,” according to excerpts of a speech Fisher delivered in Dallas. That also was similar to Warsh’s comments last week.
No wonder one press report indicated that these comments made Christy Romer “cringe.” In 1933 the US recovery gained traction, and yet in 1937, four years later, a decision to tighten policy proved disastrously premature. I have no idea how long it will be before the Fed should raise its target rate, but I know it should not come at the first sign the recovery is gaining traction. It should come when the forecast rate of NGDP is equal to the Fed’s implicit target.
And this leads to my second objection. Why are Fed officials talking about raising interest rates without any discussion of removing fiscal stimulus? You might argue that fiscal policy is none of their business, and they can’t control it anyway. Here’s how I look at things. Last year the Fed called for fiscal stimulus, basically on the grounds that they (wrongly) felt that monetary stimulus alone wasn’t sufficient. If they are going to call for fiscal stimulus when they think it is needed, then they absolutely must call for removal of the fiscal stimulus when monetary policy is, by itself, capable of providing sufficient stimulus. And logically that would occur well before the Fed was contemplating tightening policy. All I ask for is symmetry. If the Fed is going to interfere in fiscal policy, do it in both directions. After all, fiscal stimulus is far more costly (in terms of debt) than monetary stimulus.
Here’s how the markets responded to these Fed statements:
Some investors found Warsh’s comments confusing, especially coming just two days after the Fed decided to hold its key bank lending rate at a record low near zero and pledged to keep it there for an “extended period.” Most economists read that to mean the Fed would keep rates at super-low levels through this year and into part of 2010.
Warsh’s comments led some investors to believe that rate increases could come sooner.
I’m not surprised they’re confused. I am too. The standard monetary text for PhD students was written by Michael Woodford of Columbia. He shows that the most important determinant of current AD is changes in the expected path of future monetary policy. If this article is correct, and the comments “led investors to believe that rate increases could come sooner,” then these statements represent a de facto tightening of monetary policy. Let’s hope this AP story is wrong.
Update: It looks like my hopes are dashed. From last Friday’s Bloomberg.com:
Warsh’s comments and rise in a consumer confidence index caused prices on U.S. two-year notes to fall. Yields on the two- year government note rose five basis points to 0.98 percent at 4:32 p.m. in New York. Stock prices fell, with the Standard & Poor’s 500 index down 0.6 percent to 1,044.38.
PS. I forgot to give a hat tip to Marcus for the previous Fisher article.