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.
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.