Ben, please drop the employment trigger

The forward guidance policy announced last fall was widely seen as a partial victory for the NGDP targeting approach:

1.  It combined inflation with a variable closely linked to RGDP growth.

2.  It made policy conditional on the state of the economy.

The basic idea was that the Fed promised they would not raise rates AT LEAST until one of the following two things happened:

1.  Unemployment fell to 6.5%

2.  Inflation had risen to 2.5%, on a forward-looking basis.

Dropping the unemployment trigger would make policy more expansionary, and that’s a good thing.

Bernanke already seems to be having doubts about the 6.5% figure, and deep down I’m pretty sure he would agree with this post:

Bernanke said Sept. 18 that “the first increases in short-term rates might not occur until the unemployment rate is considerably below 6.5 percent.”

Why do I favor dropping the unemployment trigger; doesn’t that move us away from NGDP and toward an inflation target?  Not really, because the current policy is extremely weak precisely because there is no real “level targeting” aspect to it.  There’s no catch-up, it’s a let bygones-be-bygones approach.  If we dropped the unemployment mandate, then we’d effectively be moving to an inflation/price level target hybrid.  There would definitely be a little bit of catch-up.  Not much, just a 1/2% or so, but that’s better than nothing. Under current policy it’s quite likely that inflation will still be below 2% when the Fed starts raising rates (roughly when unemployment falls to 6%.)  I.e. there is no catch-up at all for the current policy, which is undershooting their 2% inflation target.

As a practical matter either approach would fall short of the NGDPLT ideal, indeed either approach would fall short of a 5% NGDPLT policy starting from today, with no catch-up, as NGDP growth will likely undershoot 5% either way.  But dropping the unemployment trigger would make policy slightly more expansionary, and oddly enough conservatives/libertarians might like it more, because they hate seeing the Fed target unemployment. (Indeed I seem to recall George Selgin criticizing the employment trigger.)

And best of all, there would be no loss of credibility, as the new promise would be 100% consistent with the previous promise.  A promise not to do X if A occurs, is 100% consistent with an earlier promise not to do X if A and B occurs.

HT:  Michael Darda


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28 Responses to “Ben, please drop the employment trigger”

  1. Gravatar of Why the Fed should drop its employment trigger | AEIdeas Why the Fed should drop its employment trigger | AEIdeas
    29. October 2013 at 11:49

    [...] Scott Sumner: [...]

  2. Gravatar of Philo Philo
    29. October 2013 at 11:56

    By ‘drop’, as in ‘drop the unemployment trigger’, you mean *eliminate*, rather than *reduce* (numerically).

  3. Gravatar of wiretap wiretap
    29. October 2013 at 14:02

    1. “The basic idea was that the Fed promised they would not raise rates AT LEAST until one of the following two things happened”

    2. “A promise not to do X if A occurs, is 100% consistent with an earlier promise not to do X if A and B occurs”

    As quoted in 1., the earlier promise is “not to do X if (A or B) occurs.” That’s not 100% consistent with a promise not to do X if A occurs.

  4. Gravatar of bill bill
    29. October 2013 at 14:55

    They could just lower the unemployment trigger to 5.0% or 4.0% or lower. I mean, if inflation never goes over 2.5%, why shouldn’t we do QE forever? Seriously.

  5. Gravatar of Doug M Doug M
    29. October 2013 at 15:12

    I think I preferred the more opaque Greenspan Fed. We will be easy for as long as it suits the Chairman, and if you thought he thought he suggested otherwise, you were not listening.

  6. Gravatar of Don Geddis Don Geddis
    29. October 2013 at 15:14

    wiretap: You haven’t thought the logic through. The original Fed statement was to not do X “at least until” (A or B). You changed the statement in your comment to not do X “if” (A or B). That’s a very, very different statement, and not at all the one the Fed made.

    Perhaps it would be easier to understand the Fed statement in this form: “If either A is true, or B is true, then we will NOT raise rates. If one of them is false, then we might raise rates”. Sumner is suggesting the modification: “If B (employment) happens to be false, but A (inflation) is still true, then we still promise not to raise rates.”

    This is consistent with the earlier statement, because the only original promise in the (A but not B) case, was that they “might” raise rates. Sumner is suggesting changing that one case to “won’t”, which is still consistent with the original “might”.

  7. Gravatar of ssumner ssumner
    29. October 2013 at 15:16

    Philo, Yes, eliminate.

    Wiretap, I think you misunderstood me. Obviously the statements would be different. I meant that nothing done under the new promise would violate the previous promise. So no loss of credibility.

    Bill, Sure, they could lower it to 4.0%. But why not get rid of it?

  8. Gravatar of Rajat Rajat
    29. October 2013 at 15:29

    OT, but Scott, do you have any thoughts on this exchange between Fama and CNBC’s Rick Santelli on the effect of QE? Fama talks about IOR and basically says QE has no effect on anything because the Fed issues short term securities to buy long term securities, which he says should increase short rates but has instead lowered them. Penny for your thoughts!

  9. Gravatar of dtoh dtoh
    29. October 2013 at 15:34

    Rajat,
    My $0.02. I think Fama is right on this. OMP have no effect to the extent they increase ER by an equivalent amount. However, IOR and the amount of ER are entirely within the control of the Fed and are a deliberate policy choice. IMHO, the Fed could pursue a less controversial policy path by reducing OMP and at the same time lowering IOR and ER.

  10. Gravatar of Geoff Geoff
    29. October 2013 at 16:57

    Any “spending” trigger, if ignorantly adopted, should be dropped as well.

    It would be a good thing if the Fed were abolished.

  11. Gravatar of Saturos Saturos
    29. October 2013 at 21:12

    But the result of these continual modifications which will require further modifications is to move even further from a rules-based regime…

    And the last sentence is wrong, don’t you mean, “an earlier promise not to do X if A OR B occurs.”? And even if it had been “A AND B”, the result may not be inconsistent but it is still a modification of the rule.

  12. Gravatar of Rajat Rajat
    29. October 2013 at 22:34

    dtoh, thanks for your response. But obviously QE does work and it must be because it increases the money supply. Sorry, I’m just confused because I don’t understand the mechanics of these measures well enough.

  13. Gravatar of Benjamin Cole Benjamin Cole
    30. October 2013 at 01:11

    Excellent blogging….

    Japan stayed with QE for four years, 2002-6, and that four years was their only extended economic expansion post 1992. They still had no inflation.

    So, this gets to Bill’s point (posted above): Why ever end QE?

    And to my point: If the Fed concentrates on permanently buying US debt, will not this seriously unburden US taxpayers?

    And gets to the supreme point: What if, in regularbite-sized doses, debt QE/monetization works to stimulate the economy, and reduces debt burdens with no inflation?

    This, BTW, is what the NY Fed and ST. Loo Fed more or less said would happen in calculus-strewn and awkwardly worded papers.

    Do we not do QE permanently for some sort of pre-conceived economic or even moral reasons? It seems wrong…but is that extending a personal viewpoint to the general economy…that is, of course as individuals we should pay back our debts…but can a nation pay back its debts with fresh currency, especially if no inflation results?

  14. Gravatar of Morgan Warstler Morgan Warstler
    30. October 2013 at 02:06

    I’m convince it’s the LT.

    We could set inflation target art 2.25% and lock it in, and we’d still get a rule based chuck norris effect in a shorter period of time than what we are doing now.

  15. Gravatar of dtoh dtoh
    30. October 2013 at 05:02

    Rajat, You said;

    But obviously QE does work and it must be because it increases the money supply. Sorry, I’m just confused because I don’t understand the mechanics of these measures well enough.

    In increasing the money supply was the only thing that QE did then that would be logically true, but OMP are an exchange so increasing the money supply is not the only thing that is happening. They also increase the demand for and price of financial assets. That’s the mechanism.

  16. Gravatar of ssumner ssumner
    30. October 2013 at 06:29

    Rajat, He’s right that IOR should increase short rates to 0.25%. They seem to have risen, but to less than 0.25%. Not sure why, I think it had to do with the GSE reserve holdings not earning interest.

    Remember, however, the effect of QE on the economy comes through the hot potato effect, not lower rates.

    Saturos, But it makes the rule more specific, which reduces policy discretion. Under the current rule they can raise interest rates or not raise interest rates when inflation is 2.2% and unemployment is 6.2%. My rule forces them to not raise rates. It takes away discretion.

    And it’s A and B, not A or B. The Fed said it won’t raise rates if unemployment is above 6.5% and inflation is below 2.5%. It said nothing about what it would do if only one occurred.

  17. Gravatar of Matt McOsker Matt McOsker
    30. October 2013 at 07:29

    Targeting 6.5% or even 4% seems silly given the denominator has been declining. If low unemployment does not have major negative price or other negative implications, then let it drop.

    Scott RE IOR. From: http://www.newyorkfed.org/aboutthefed/fedpoint/fed15.html

    “While IOER has been effective at influencing the FFER, it has not served as a hard minimum rate at which all institutions are willing to lend funds. This is because some institutions are eligible to lend funds in the federal funds market, but are not eligible to earn IOER, such as the government-sponsored enterprises (GSEs). DIs, U.S. branches and agencies of foreign banks, Edge Act and agreement corporations, and trust companies are eligible to receive interest on reserves and excess reserve balances held at the Federal Reserve. Pass-through correspondents that are themselves eligible to receive interest may pass the interest they receive on balances that represent their respondents required reserve balances and excess balances, but they are not required to do so. By contrast, pass-through correspondents that are not themselves eligible to receive interest must pass back to their respondents the interest they receive on balances that represent their respondents required reserve balances. Other factors that influence the rates some institutions are willing to pay for fed funds in this environment include the impact on their balance sheet, which often determines a maximum rate a DI is willing to pay.”

  18. Gravatar of dtoh dtoh
    30. October 2013 at 15:25

    Scott, you said;

    “Remember, however, the effect of QE on the economy comes through the hot potato effect, not lower rates.”

    Scott you have previously said many times, it comes through HPE and asset prices (i.e. lower rates).

    You’re right about asset prices but not about HPE.

    As you have also implied in a very recent post, HPE describes an equilibrium condition. It doesn’t explain the mechanism which results in that equilibrium.

    To make it perfectly clear. QE works through expectations and through asset prices. HPE is a mythical creature just like the ZLB.

  19. Gravatar of Scott Sumner Scott Sumner
    31. October 2013 at 12:45

    Matt, Now can someone translate that into English? Why don’t banks borrow reserves at 0.1% in the fed funds market, and earn 0.25% on the reserves? Riskless arbitrage?

    dtoh, Asset prices rise due to the HPE. And lower rates are not a very important part of the asset market mechanism.

  20. Gravatar of dtoh dtoh
    31. October 2013 at 15:57

    Scott, you said;

    ” Asset prices rise due to the HPE. And lower rates are not a very important part of the asset market mechanism.?

    Nope!…. asset prices rise because the Fed is buying assets. (I.e. they are selling money (subway tokens to use the analogy) at a lower price relative to financial assets. Because of sticky prices/wages, the price of real goods and services also fall relative to the price of financial assets.

    If you do a separate post on how expectations impact asset prices, I’ll comment on it.

  21. Gravatar of ssumner ssumner
    31. October 2013 at 18:07

    dtoh, It’s not because they are buying assets. Asset prices would rise if the money was dumped out of a helicopter.

  22. Gravatar of dtoh dtoh
    31. October 2013 at 18:12

    Scott,
    Yes they would, but so would the price of goods and services. Thus no change in the relative price of assets vs. goods/service, thus no marginal increase in the exchange of assets for goods and services. You’d get a rise in NGDP, but it would all be nominal.

  23. Gravatar of Secondary Sources: Household Debt, Fed Triggers, Global Growth – Real Time Economics – WSJ Secondary Sources: Household Debt, Fed Triggers, Global Growth - Real Time Economics - WSJ
    2. November 2013 at 04:17

    [...] –Fed Triggers: Scott Sumner wants the Fed to drop the unemployment rate trigger for rate increases. “Why do I favor dropping the unemployment trigger; doesn’t that move us away from NGDP and toward an inflation target? Not really, because the current policy is extremely weak precisely because there is no real “level targeting” aspect to it. There’s no catch-up, it’s a let bygones-be-bygones approach. If we dropped the unemployment mandate, then we’d effectively be moving to an inflation/price level target hybrid. There would definitely be a little bit of catch-up. Not much, just a 1/2% or so, but that’s better than nothing. Under current policy it’s quite likely that inflation will still be below 2% when the Fed starts raising rates (roughly when unemployment falls to 6%.) I.e. there is no catch-up at all for the current policy, which is undershooting their 2% inflation target.” [...]

  24. Gravatar of ssumner ssumner
    3. November 2013 at 06:23

    dtoh, No, if money was dumped out of a helicopter then prices and wages would still be sticky, or slow to adjust.

  25. Gravatar of dtoh dtoh
    3. November 2013 at 09:13

    Scott,
    No. Only the first time or if the drops were somehow done secretly. Once expectations adjusted, behaviour would change and drops would result in an immediate adjustment to all prices.

  26. Gravatar of jknarr jknarr
    3. November 2013 at 10:01

    Dtoh, what would happen if the Fed revalued its gold asset on the balance sheet to $1,000/oz and printed up corresponding reserve and currency liabilities?

    Also, we should consider that the banking system does not necessarily prioritize economic efficiency and output. It’s also about regulating economic activity and social control.

    http://www.nytimes.com/2012/10/25/us/liberty-dollar-creator-awaits-his-fate-behind-bars.html?_r=0&pagewanted=all

    http://arstechnica.com/tech-policy/2013/11/digital-currency-service-founder-pleads-guilty-faces-75-years-in-prison/

  27. Gravatar of ssumner ssumner
    4. November 2013 at 09:55

    dtoh, We’ll have to agree to disagree on that one, I feel very strong that Bentley would not give me an immediate wage increase, but rather would wait until next year.

  28. Gravatar of dtoh dtoh
    4. November 2013 at 20:24

    Scott,
    Not the first time, but once the Fed started doing it in a regular and expected manner, the price changes would all become instant and automatic.

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