Don’t mix up tactics and strategy (The Straight Story)
Here’s commenter Philo, quoting me and then responding:
“It’s hard to evaluate current policy without knowing where the Fed wants to go, and they refuse to tell us where they want to be in 10 years, either in terms of the price level or NGDP. If they would tell us, I’d recommend they go there in the straightest path possible.” But why accept the Fed’s objective, whatever it may be, as valid? If they wanted to take us to hell, would you recommend that they do so as efficiently as possible? I think the Fed needs your advice about *what objective to aim for*, as well as about how to achieve that objective.
I do give the Fed both kinds of advice, but it’s very important not to mix them up. Suppose while living in Madison I get into an argument with friends about whether to vacation in Florida or California. I lose the argument and we decide on Florida. I’m in charge of directions. Do I have the car head SW on highway 151, or southeast on I-90? If I suggest southwest, because I want to go to California, then when the vegetation starts getting sparse they’ll realize we are going the wrong way, and lots of needless extra driving will occur—the travel equivalent of a business cycle.
Now suppose I favor 5% NGDP growth and the Fed favors something closer to 3% in the long run. In that case I may suggest they change their target to 5%, but it’s silly for me to give them tactical advice consistent with a 5% target. After a few years of that we’d plunge to 1%, to create the 3% long run average. Again we’d get a needless business cycle. Whichever way they want to go, I’d like them to go STRAIGHT.
Tyler Cowen has a post that links to a FT story warning of a possible repeat of 1937. They should have warned of a possible repeat of 1937 and 2000 and 2006 and 2011, when various central banks tightened prematurely at the zero bound. Did they ever tighten too late? Yes, in 1951, in circumstances totally unlike today. So yes, I’m worried about a repeat of 1937. I currently think the odds are at least 4 to 1 against a double dip recession next year, but I’d like to see the Fed make those odds smaller still.
Tyler also links to a Martin Wolf piece that starts out very sensibly; pointing out that low rates do not mean money has been easy. But then Wolf slips up:
The explosions in private credit seen before the crisis were how central banks sustained demand in a demand-deficient world. Without them, we would have seen something similar to today’s malaise sooner.
I see his point, and it’s true in a certain way. But it’s also a bit misleading. It would be much more accurate to say that central banks sustained demand by printing enough money to keep NGDP growing at 5%, and could have continued doing so if they had wished to. It so happens that bad regulatory policies pushed much of that extra demand into credit financed housing purchases, instead of restaurant meals, vacations, cars, etc. But that has nothing to do with monetary policy, which is supposed to determine AD.
Tyler comments on the debate:
I see a few possibilities:
1. Stock and bond markets are at all-time highs, and we Americans are not so far away from full employment, so if we don’t tighten now, when? Monetary policy is most of all national monetary policy.
I’d say we tighten when doing so is necessary to hit the Fed’s dual mandate. And how are stock and bond prices related to that mandate? And what does Tyler mean by “tighten?” Does he mean higher interest rates? Or slower NGDP growth (as I prefer to define tighten)?
I do agree that the Fed should focus on national factors, but otherwise I think Tyler needs to be more specific. Is he giving advice about tactics or strategy? Does he believe this advice would help the Fed meet its 2% PCE inflation target? If so, then why? Notice that the inflation rate is not mentioned in his discussion of what the Fed should do, even though the Fed has recently adopted a 2% inflation target (2.35% if using the CPI), and is widely expected to undershoot that target for years to come.
2. It’s all about sliding along the Phillips Curve. Where are we? Who knows? But risks are asymmetric, so we shouldn’t tighten prematurely. In any case we can address this problem by focusing only on the dimension of labor markets and that which fits inside the traditional AD-AS model.
I agree with this, although I think the first and last parts of it are poorly worded. I think he’s saying that we don’t know where we are relative to the natural rate of unemployment, which is true. But the term ‘Phillips Curve’ is way too vague, unless you are already thinking along the lines I suggested. Yes, the risk of premature tightening is important. Even worse, the risks facing the Fed are somewhat asymmetric, due to their reluctance to target the forecast at the zero interest rate bound. So excessively tight money will cost much more than excessively easy money, in the short run. But what about the long run? Again, that depends on the Fed’s long run policy goals, and they simply won’t tell us. For instance, if the policy was something like level targeting, then the risks would again become symmetric–overshoots are just as destabilizing as undershoots under level targeting. That’s one more reason to switch to level targeting.
I also find the last part to be rather vague (although maybe that just reflects my peculiar way of looking at things.) I certainly think the labor market and AS/AD are the key to monetary policy analysis, but those terms can mean different things to different people. I think Tyler sometimes overestimates the ability of his readers (including me) to follow his train of thought. “Labor market” might mean nominal wage path or U-3 unemployment. Those are actually radically different concepts, as the first is a nominal variable and the other a real variables.
Tyler continues:
3. The Fed’s monetary policies have created systemic imbalances, most of all internationally by creating or encouraging screwy forms of the carry trade, often implicit forms. A portfolio manager gains a lot from risky upside profit, but does not face comparable downside risk from trades which explode in his or her face. The market response to the “taper talk” of May 2013 (egads, was it so long ago?) was just an inkling of what is yet to come.
Which “policies?” Is he referring to excessively easy or excessively tight money? No way for me to tell. I think policy has created imbalances by being too tight. I think an easy policy would have led to fewer imbalances. But most people believe exactly the opposite. Given that Tyler wants to be understood, it’s probably better to assume he’s addressing “most people.”
How has the Fed’s monetary policy contributed to the carry trade? At this point I know that some people will want to jump in and insist that it’s all about interest rates. But interest rates are very different from monetary policy. And even if you think low rates are the issue, you’d have to decide whether the low rates were caused by easy money or tight money. As I just mentioned, even sensible non-MMs like Martin Wolf are now skeptical of the idea that they reflect easy money. So if low rates are the problem, should money have been even easier? Easy enough to produce positive nominal interest rates such as what we see in Australia? But wait, Australia’s having the mother of all housing “bubbles,” “despite” the fact that their interest rates are higher than in other countries. (Sorry for two consecutive scare quotes; I’m getting so contrarian that I’ve almost moved beyond the capabilities of the English language. Maybe that’s a sign I should stop here.)
No, I’m not done yet. Why does 2013 suggest that Fed policy has a big effect on emerging markets? As I recall, the unexpected delay in tapering in late 2013 had a very minor impact, suggesting the earlier EM turmoil mostly reflected other issues, not taper fears.
4. The Fed’s monetary policies have created systemic imbalances, most of all internationally by creating or encouraging screwy forms of the carry trade, often implicit forms. Fortunately, we have the option of continuing this for another year or more, at which point most relevant parties will be readier for a withdrawal of the stimulus. That is what patience is for, after all. To get people ready.
OK, now I see. I misread what Tyler was doing—these are “possibilities” not his actual views. Yes, the Fed should be patient here, but certainly not in order to bail out speculators.
5. We should continue current Fed policies more or less forever. Why not? The notion of systemic imbalances is Austrian metaphysics, so why pull the pillars out from under the temple? Let’s charge straight ahead, because at least we know the world has not blown up today.
Forever? If “Fed policies” means the relatively steady 4% to 4.5% NGDP growth over the past 6 years then yes, by all means let’s continue them forever. If it means zero interest rates, then no.
Of course now that I know that these are not necessarily Tyler’s views, I can see some sarcasm in the last sentence. Once again, it all comes down to how we define monetary policy, how we define “straight ahead.”
At least physicists know the difference between up and down. It’s a pity that economists continue to debate the proper stance of monetary policy without having a clue as to what the phrase “stance of monetary policy” means. As we saw in 2008, that confusion is unlikely to end well.
Alternatively, once we all agree to go straight ahead, we need to find some way to agree on what “straight” means.
PS. The old man in The Straight Story (who reminded me of my dad) went the opposite way from what I proposed–northeast towards Wisconsin.
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18. March 2015 at 09:26
Great post.
In related matters, Lars Svensson’s lastest rant concerning his former central bank colleagues is a thing of beauty:
http://larseosvensson.se/2015/03/17/riksbank-deputy-governor-jansson-again-tries-to-defend-the-indefensible/
Many similarities with the current situation:
-Inflation prediction markets under target
-Several employment indicators indicate there is still quite a bit of slack left (U-6, employment-population ratios, total hours worked)
-Consumer confidence is low (ok, that was not in Svensson’s post, but close enough)
The comparison to 1937 may unfortunately be appropriate.
On the other hand, the Hypermind prediction suggests that the Fed is on course to reach 4% NGDP growth. This year will be a good test of the predictive power of the Hypermind numbers.
18. March 2015 at 10:16
Scott, if you follow the full implications of your recognition that many countries had a housing “bubble” but not a bust – and you should – then there is no reason to “blame” US housing policies for something that didn’t happen. The growth in housing values was mostly in equity, until values collapsed – not mortgages. And, toward the end of the boom, it was increasingly from high income households looking for investment income – not low-income owner-occupiers incentivized by housing and tax policy.
http://idiosyncraticwhisk.blogspot.com/2015/02/housing-tax-policy-series-part-11-low.html
http://idiosyncraticwhisk.blogspot.com/2015/02/housing-tax-policy-series-part-12-low.html
http://idiosyncraticwhisk.blogspot.com/2015/03/housing-tax-policy-series-part-20-never.html
18. March 2015 at 10:26
Kevin Erdmann,
Great stuff, thanks!
18. March 2015 at 10:32
Interesting: “Here Is The Reason Why Stocks Are Soaring, Or Farewell “Recovery”… Again”
http://www.zerohedge.com/news/2015-03-18/here-reason-why-stocks-are-soaring-or-farewell-recovery-again
18. March 2015 at 10:42
>>we need to find some way to agree on what “straight” means>>
It means towards maximum employment and 2% inflation. They do not list GDP or NGDP as targets.
18. March 2015 at 10:45
If stocks go down, ZH says it means economic doom. If stocks go up, ZH says it means economic doom.
If I read the ZH post right, the estimates “revised down” by the FOMC include unemployment to 5%-5.2% from 5.2%-5.3%. I guess unemployment was in fact revised down literally.
The true fatal flaw in the ZH post is the general flaw with the mentality of most traders (ZH, FT Alphaville, etc.). The Fed is not just another trader “distorting” the actual “reality” of the market. As far as NGDP and cyclical unemployment, the Fed makes the reality!
The tough issue is whether today’s FOMC statement is loosening or tightening policy. The stock market seems to indicate it is loosening policy. However, the stock market has an interest rate component. You have to disaggregate the future cash flows, which relate to NGDP, from the interest rates. The stock market went down in the 70’s as policy loosened, because the discount rate increased along with inflation.
IMO, the statement seems like a loosening of policy. Lower interest rates can mean tighter policy because NGDP growth is not happening, but the Fed having lower interest rates while keeping NGDP growth constant is looser policy. I believe it is the latter.
18. March 2015 at 10:51
Yellen was asked pretty point-blank just now “If your inflation forecasts continue to be low, and you said you won’t raise rates without confidence that inflation is at target, why do you still forecast raising rates?” Yellen’s disposition seemed to change a good bit and she had to give a mealy-mouthed answer about looking at a “wide range” of data. Then for all the data she cited, including wage growth and TIPS spreads, she mentioned they all point to below-target inflation.
18. March 2015 at 10:54
>>If I read the ZH post right, the estimates “revised down” by the FOMC include unemployment to 5%-5.2% from 5.2%-5.3%. I guess unemployment was in fact revised down literally.>>
You might be better of using the Fed (statement and press conf) as a source rather than reading ZH.
That said, they revised unemployment down, as well as revising down some other things.
18. March 2015 at 11:08
Yeah, I was too lazy to bring up the primary source. I just think it’s funny too that ZH announced “the Fed revised down all their economic indicators and ‘farewell’ recovery!” including “revising down” unemployment. Uh, well, yes that’s true but…
18. March 2015 at 11:08
BTW, Yellen just said it would be a mistake to mandate that the Fed follow any simple mathematical or mechanical rule, such as a Taylor rule.
No one has asked about NGDP or level targeting. It would be nice if a reporter could be convinced to ask about this.
18. March 2015 at 11:10
“That ZH article is ridiculous” is a safe reaction to any ZH article. 🙂
18. March 2015 at 12:04
Scott and others,
I posted this question over at MR, but only Ray Lopez bit, so now I’m a tiny bit dumber than I was (Who loves ya Ray?).
Anyhoo, any thoughts are appreciated:
I have a question.
Is the ‘Wicksellian interest rate’ a nominal or a real rate?
Also, is it more appropriate to think of the Wicksellian rate as a yield curve rather than a single number?
I’m guessing the concept refers to a real yield curve. Please correct me if I’m wrong.
If I’m correct then, in theory, is it possible to gauge the stance of monetary policy by simply comparing the TIPs curve to this Wicksellian curve?
So, if the TIPs curve is below the Wicksellian curve, policy would be perceived as ‘accommodative’.
Two problems are: (1) no one knows where the Wicksellian curve is at any given time, and (2) it doesn’t sit still itself.
But do I have the theory right? Or is this a dumb way of thinking? Or both?
Thanks.
18. March 2015 at 12:29
Thanks LK, I did a post.
Kevin, When I say “housing policies” I am blaming many different policies, including regulation of the banking system:
1. Mortgage interest deduction
2. FDIC
3. Fannie and Freddie
4. TBTF
5. CRA
All contributed, as did many other policies.
foosion, How can you have a straight line going toward two different objectives? You need to boil it down to one variable (which might be a composite of those two.) And then go straight toward that variable.
18. March 2015 at 12:33
Brian, It can be a nominal or real rate, however you want to define it. It’s usually defined as a short term rate, because it’s used to compare to the policy rate (which is also short term.) It does move around and is very hard to observe, so I don’t really like the concept. The only way we could really know the Wicksellian rate would be to peg NGDP futures. Then it would be equal to the actual rate.
18. March 2015 at 12:40
Sumner’s car analogy is imperfect: if the Fed has a steering wheel, it’s more like a kiddy’s fake steering wheel, where input by the Fed has no effect on which way the car (the economy) moves. As I pointed out to Brian Donahue in the other post, during the Volcker Fed, Volcker *loosened* money and inflation *fell* (he also tightened and inflation rose, then fell, the point being, it was not a one-to-one linear relationship). The excellent paper from 2011 linked by another poster a few days ago, “Towards a New Research Programme on ‘Banking and the Economy’ – Implications of the Quantity Theory of Credit for the Prevention and Resolution of Banking and Debt Crises Richard A. Werner” points out the impotence of monetary variables controlled by the Fed. Yet Sumner et al cling to the fallacy that the Fed steers the economy.
18. March 2015 at 14:07
>>How can you have a straight line going toward two different objectives? You need to boil it down to one variable (which might be a composite of those two.) And then go straight toward that variable.>>
The Fed is legally mandated to pursue maximum employment and price stability.
“maximum employment and 2% inflation” is a phrase Yellen used repeatedly at today’s press conference.
To the extent they are inconsistent objectives (as they so often are), then there must be a balance. The Fed obviously prefers to make it up as they go along. Yellen today explicitly rejected any mechanical rule.
I’m just reporting here.
18. March 2015 at 15:33
Professor Sumner I think I am getting close to understand your ideas, but I must confess, talking to other people I know, mostly practitioners, they are very skeptical that trying to reach 5% NGDP grotwh will lead to “more stable” rates. We know that you bet on expectations to be anchored, but still… Now, I do have a question about NGDP level targeting. What if potential RGDP does structurally fall to, for the sake of the argument, 0%, and in the first year, even with monetary easing, NGDP is 3%. This calls for a monetary policy stance that will lead to 7% NGDP growth next year. Playing devil’s advocate, let’s assume further that potential RGDP was indeed zero and remained there. Wouldn’t the level of stimulus need to be so large that would be impractical? Also, if you achieve your goal of 7% NGDP in the second year, that would mean 7% inflation. Wouldn’t that be bad in the sense that relative prices would be changing very fast and, maybe, this would be counterproductive in the long run? Wouldn’t it be better to stick with NGDP rate targeting, and forget about the past ? Thank you …
18. March 2015 at 15:34
Sumner wrote:
“After a few years of that we’d plunge to 1%, to create the 3% long run average. Again we’d get a needless business cycle.”
Falling NGDP is not the cause of business cycles. Falling NGDP is an effect of the same cause of business cycles.
You are mistaking correlation for causation, and injecting a false theory of markets.
Still you have not studied or researched why it is that so many people all around the same time decide to hold onto their money earnings for a longer period of time.
Spending does not fall for no reason. And no, an explanation of the cause of that is not the absence of something. The cause of cancer is not an absence of treating it.
18. March 2015 at 15:45
Sumner wrote:
“It so happens that bad regulatory policies pushed much of that extra demand into credit financed housing purchases, instead of restaurant meals, vacations, cars, etc. But that has nothing to do with monetary policy, which is supposed to determine AD.”
False!
Inflation ITSELF “pushes” demand into the wrong projects. Inflation of reserves into the banking system affects interest rates EVEN IF the central bank does not target them. Interest rates are the regulator of capital allocation in the temporal sense of when consumers want to consume.
Regulation does not cause this. Regulation can only redirect where the necessary bad demand push malinvestment goes. It just so happened that during the 2000s there was bad housing regulation, so a large portion of the malinvestment arose there.
But what about dot coms? The NASDAQ bubble and bust? There were no “bad regulations” in software development that differed from past years. No, the boom concentrated there for historical reasons. But the malinvestment had to go somewhere, because of the “bad monetary” regulations that are endogenous to inflation itself.
This is your blind spot Sumner! It is clear as day.
Inflation itself REDIRECTS resources.
18. March 2015 at 15:47
“Wouldn’t it be better to stick with NGDP rate targeting, and forget about the past ? Thank you …”
Great question. I myself have always wondered as to why the necessity to play catch up.
18. March 2015 at 16:09
Scott Sumner–excellent blogging, but please, a 4.5% NGDPLT is way too low…the Fed economy blue-face special…
Live a little! Try 6%. Breathe! And remember, it is the Phillips Phlat-Line. It takes a whole lot of unemployment to cut inflation by 1%. Conversely, you gotta have help-wanted signs on every shop in America to raise inflation up by 1%.
Rev up the presses!
18. March 2015 at 19:26
Benjamin Cole:
6% is way too tight. That is purple faced suffocation. Must. Breathe!
Let’s print like it’s Weimar! The fresh air! Oooo…feel the oxygen! Yes! Let the lungs expand!
Heck why not 10%! Woweee! Imagine the boost of that sweet sweet oxygen! Aaahhhhhhh
18. March 2015 at 20:23
@Jose Romeu Robazzi – ah, welcome to the inner chamber of Sumner Skeptics brother…you have cracked the code. Now watch Sumner ignore you, like he does MF, and like he has threatened to ignore me. Like in the Wizard of Oz, you have pulled back the curtain and exposed a frail little man at the controls…
Jose: “Wouldn’t the level of stimulus need to be so large that [it] would be impractical? ” – indeed.
18. March 2015 at 20:25
@myself – sorry forgot to mention the story of the Wizard of Oz is said to be allegorically a take on the monetary impotence of the US Federal Reserve…
19. March 2015 at 00:37
It so happens that bad regulatory policies pushed much of that extra demand into credit financed housing purchases
Which remember, everyone thought was a great bipartisan idea at the time, because Houses Are An Investment and Prices Never Go Down and Ownership Society and of course the government was here to help make all this happen, and celebrated the historic 79% ownership rate.
They pushed looser standards into the credit markets and at the same time were too timid to push looser money to ease the crisis when the risks were exposed.
19. March 2015 at 05:05
Ray,
I am not a skeptical, I am an enthusiast, at least as far as the theoretical concept is concerned. I am worried about practical implications of the concept. As a practitioner, I am sympathetic to Austrian views of the economy, but not the gold standard. Austrians praise natural law, therefore, they should acknowledge that financial innovation and technology have rendered gold standard obsolete. The universal move away from the gold standard should be regarded as evolution. Now, having said that, I am not sympathetic to discretionary monetary control by a group of experts in a room, no matter how good governance is. Obviously, their decision will affect the lives of billions of people, and as Summner has pointed out many times, in the current assembly they are not accountable, and they can set their own objectives. Economist in the frontier of macroeconomic research should provide some sort of nominal anchor for the market participants, and that is exactly what Sumner has done, and deserves praise for it. As a pracitioner, I am trying to make a modest contribution. And before somebody accuses me, I am not the same person as Ray Lopez and Major Freedom… Regards to all
19. March 2015 at 05:43
@benjamin, Scott Sumner has mentioned that a too high NGDP rate acts as a tax on capital. Capital building is the only way to get rich, so capital building should not be discouraged.
19. March 2015 at 06:09
foosion, I know you are just reporting, but those aren’t good answers. NGDP targeting fulfills the Fed’s dual mandate.
Jose, It MIGHT be bad for the reasons you suggest, but more likely it would be good because the volatility of NGDP would be much less under NGDP level targeting. Since the market knows you’ll return to the trend line in the future, it falls less in the near term. The Great Recession never would have happened if we’d known that NGDP would be 15% higher in 3 years.
By the way, my actual preferred policy is targeting NGDP per capita, or even better per person age 21-64. That can easily accommodate a slowdown in population growth.
Ben, The key is stability. KISS, “keep it stable, sensible person.”
Ray, You said:
“sorry forgot to mention the story of the Wizard of Oz is said to be allegorically a take on the monetary impotence of the US Federal Reserve…”
Yes, there is no doubt that a book written in 1900 was an allegory of Fed policy. Prophetic too.
19. March 2015 at 06:37
@Jose, Contracts are made on the basis of the expected long term growth. If the world is eventually expected to return to 3’ish growth, your description is that of a temporary supply shock. Expanding the money supply to accomodate the money demand, even to the extent of inflation of 7% is the correct policy.
What if it is not temporary? Year after year, we’re just getting inflation and no RGDP growth? Then, I think the government should cut transfer payments, seriously reform economic policy and the CB should re-target to a lower NGDP growth path.
19. March 2015 at 08:34
Sumner
Level targeting = stronger commitment, more effectiveness
Prakash
if we keep getting more inflation and less growth it signals something other than monetary policy should be dealt with and/or perhaps change the target itself
I was thinking on those lines, but wanted to hear from you. Thanks all.
20. March 2015 at 13:57
@Ray Lopez: “if the Fed has a steering wheel, it’s more like a kiddy’s fake steering wheel, where input by the Fed has no effect on which way the car (the economy) moves”
If you think the Fed is impotent, and completely irrelevant to the economy, then why do you bother posting here? Why does it matter what we’re all discussing?
It’s like we’re arguing about the color of physical money, and some people think “greenbacks” cause greater wealth, and others think we’d get more growth if money were blue. But you (rightly!) think that the color of money is irrelevant to economic growth. If so, why are you here? Why not just let us argue about paint colors in peace? According to you, none of it matters.
Or … are you actually making a mistake, even in reporting your own internal beliefs? Could it be, that you can’t even articulate your own position correctly?