Archive for the Category Monetary Policy


When should we be worried about monetary policy?

During late December, there was a lot of chatter in the press and the blogosphere about monetary policy.  Many pundits expressed concern that policy was off course.

Back in September 2010, there was relatively little chatter about monetary policy.  Why is there a great deal of discussion at some points in time, but not others?  One answer is that people talk about monetary policy when it is not hitting its targets.

Let’s look at the most recent unemployment and (PCE) inflation data that was available as of late September 2010 and late December 2018:

August 2010:  12-month PCE inflation = 1.38%, unemployment = 9.5%

November 2018:  12-month PCE inflation 1.84%, unemployment = 3.7%

Hmmm, which set of data points is closer to hitting the Fed’s dual mandate?

Which set of data points suggest that policy is clearly off course?

It might be argued that the Fed was out of ammunition in September 2010.  Actually, that is not the case:

1.  Bernanke insisted the Fed had more ammunition.

2.  The Fed was paying interest on reserves.

3.  The Fed was not doing quantitative easing.

4.  The Fed was not doing significant forward guidance.

So why was there a lot of discussion of the Fed being off course in late December of last year, but very little discussion in September 2010?

1.  A lack of understanding that if AD is too high or too low it’s always 100% the Fed’s fault.

2.  An inability to understand what it means for money to be easy or tight.

Thus most pundits wrongly assumed the Fed was tightening policy in 2018, even as NGDP growth picked up.  This so-called tightening was seen as a “concrete step” that threatened the recovery.  In 2010, policy was wrongly seen as being “expansionary”, and the Fed was wrongly seen as being not responsible for the fact that AD was currently far too low to achieve the Fed’s dual mandate.

Bottom line:  When discussion of monetary policy is at its highest pitch, there is often less cause for concern than when almost no one it talking about it.  Consider late 2008, when monetary policy was disastrously off course, and yet there was almost no discussion of that fact in the media.

That’s not to say that policy is not currently off course—it may well be.  Rather my point is that any errors in the current policy setting are trivial compared to 2008 or 2010, when people were mostly ignoring the Fed.

Kocherlakota wins 2013 (and Powell loses)

The minutes for 2013 were just released, and I’ve only had time to consider the January transcript. It’s clear that Narayana Kocherlakota is the clear winner.

Most people will focus on the fact that Kocherlakota’s 2013 policy advice (to be more stimulative) was clearly superior, evaluated in retrospect. I pay little attention to that fact, as it might have been merely due to luck. Rather I’d focus on the fact that Kocherlakota laid out a clear and logical approach to monetary policy determination, which was superior to that of the other FOMC members:

Mr. Chairman, my comments are not about the specific changes, but rather about the statement in its entirety. I supported the statement, what I’ll be calling the “principles statement,” a year ago. Today I’d like to reaffirm my support, but even more enthusiastically. By design, the principles statement encompasses a wide number of approaches to the making of monetary policy. Nonetheless, over the past year, I have found it to January 29–30, 2013 be sufficiently specific to provide valuable guidance when thinking about the appropriate stance of policy. To explain my thinking, Mr. Chairman, I think it’s helpful for me to refer back to a speech that you gave in December 2004 called “The Logic of Monetary Policy.” In that speech, you contrasted two approaches to monetary policy. Under what you called the “simple feedback” approach, the central bank responds in a relatively automatic fashion to the evolution of current and past variables. The Taylor rule is one example of this approach. In contrast, under the second, the “forecast-based” approach, the central bank chooses the action that it forecasts will produce the best overall results, taking account of the risks to the economy. Thus, if the central bank judges its results relative to targets for inflation and unemployment, it chooses the policy that is forecast to bring the economy closest to those targets. Lars Svensson has been a particularly vocal proponent of this approach.

As I’ll describe, my reading of what will now be the penultimate paragraph of the principles statement is that it is firmly grounded in the forecast-based approach. Correspondingly, that paragraph has led me to put considerably more weight on the forecast based approach in my own thinking about policy. The opening sentence of that key operational paragraph says that we should begin by asking, will the current path of monetary policy result in deviations between inflation and the longer-run goal of 2 percent? Equally, will it result in deviations between employment and its maximum level? The current policy path does imply such deviations. Then that same first sentence prescribes that we should adopt monetary policy actions to mitigate them. Suppose, for example, that given the current policy path, inflation is expected to run below its longer-run target over the next year or two and employment is expected to run below its maximum level. Then that first sentence implies that we should seek to mitigate those deviations by adding accommodation. Of course, decisions are more difficult when only January 29–30, 2013 one of the two variables is expected to be below its desired level. For example, suppose the current policy path is expected to lead to inflation of exactly 2 percent over the next few years, but also to lead to employment being below its maximum level. Here the second part of the paragraph provides the needed guidance. It espouses a balanced approach in the situation, and this means, I think, that we should add accommodation to mitigate the employment deviation. So I posited that inflation was exactly 2 percent. Adding accommodation would end up resulting in inflation running somewhat above target. But this is, I think, what a balanced approach has to mean: that monetary policymakers are willing to follow policies that give rise to slightly positive inflation deviations in order to mitigate negative employment deviations. The Committee has, of course, explicitly evinced that kind of willingness in the December 2012 FOMC statement.

Key takeaways:

1. Kocherlakota understood that the Fed needed clear policy goals.

2. Kocherlakota understood that policy needed to be set at a position where the Fed forecast equaled the Fed target for those goal variables.

3. Kocherlakota understood that the Fed’s dual mandate implied that if both targets could not be hit at the same time then inflation should be countercyclical, that is, above 2% inflation when unemployment is high, and vice versa.

4. Kocherlakota understood that the 2013 Fed economic forecast under the (consensus) “Alternative B” policy option was expected to lead to below target inflation and employment, and hence that the consensus policy choice was too tight.  This is discussed later in the transcript:

Now, as I said in the previous go-round, given the current stance of policy, I expect inflation to average less than 2 percent over the next two years, and I expect unemployment to remain above 7 percent over the next two years. This forecast conforms closely to the outlook described in alternative B and in the outlook in the Tealbook, and I think it’s actually fairly similar to a wide range of the forecasts we’ve heard around the table, certainly on the inflation front. So we’re confronted with a small negative deviation relative to our inflation goal and a January 29–30, 2013 large negative deviation relative to our employment goal. Yesterday, Mr. Chairman, we took the step of reaffirming the principles statement, the long-run goals and strategy statement, which I think will, over time, assume a quasi-constitutional status in this Committee. I think that statement is clear in its operational, penultimate paragraph about what needs to be done in this situation. The Committee should seek to mitigate these deviations from its goals by adding accommodation.

PS.  There’s discussion in the press of how Bernanke was pressured by the “three amigos” to slow down the QE program.  This led to the famous “taper tantrum” of 2013.  Ironically, two of those “amigos” were Obama appointees to the Board.  Their pressure to curtail QE might have slowed the recovery enough to cost Hillary the election (although of course it’s hard to be sure—in a close election almost anything can swing the result.)  Even more ironically, one of those Governors was appointed by Trump to be Fed chair, despite it being well known that his views were more hawkish than those of Yellen.  Fortunately, he is doing a good job so far, if one judges by the Lars Svensson criterion.

My views on monetary policy: An update

It’s time to update my current preferences on monetary policy:

Monetary authority structure:

1.  As in the UK, monetary policy decisions should be made by a committee of monetary specialists.  They need not be economists, but they must be experts. Self-taught is fine. Financial regulatory decisions should be made by a separate (Treasury) committee, composed of experts on finance.

2.  The FR Board should continue to be independent.  The regional Fed banks should be abolished.

3.  The Fed balance sheet should be moved over to the Treasury so that the Fed does not incur any balance sheet risk.

4.  Anyone should be able to have a “reserve” account at the Treasury. It would pay no interest.  I.e., electronic cash.

5.  Paper currency should not be abolished (as it provides privacy.)

Policy Tool:

The Fed should use just one tool, open market operations.  Generally these operations should involve Treasury securities.  There’s no need for the Fed to recommend discount lending, reserve requirements and interest on reserves as tools of monetary policy.  Other assets should be purchased only if necessary.  If we don’t get my optimal NGDP level targeting strategy and the zero bound problem occurs frequently, then there is a much stronger argument for making the purchase of other (non-Treasury) assets a routine part of policy.  Bank bailouts should be done by the Treasury, if at all. (Hopefully not at all.)  There should be an iron curtain between the Fed and the banking system, like the separation of church and state.

Policy Target:

Nominal growth targets should be high enough to avoid the zero bound problem.  With level targeting, a 4% NGDP growth rate should be high enough.  We should target expected per capita NGDP growth, level targeting.  (Perhaps growth of one basis point a day is a nice round number, for that future time when “big data” allows us to know daily changes in NGDP.)  A nominal total labor compensation target is better for some countries.  The Fed should completely offset the impact of any fiscal policy action.

Policy Rule:

The Fed should commit to a “guardrails approach”, a willingness to sell unlimited NGDP futures contracts at a implied NGDP growth rate slightly above target and buy unlimited NGDP futures contracts at an implied NGDP growth rate slightly below target.

Policy Accountability and Transparency:

The Fed should report to Congress twice a year on the effectiveness of previous policy decisions.  They should explain whether, in retrospect, policy settings adopted 12 months earlier were too easy or too tight, even if only slightly so.  They should clearly explain the metrics they used to make this determination.  This form of accountability is especially important if NGDP targeting is not adopted, less so if it is.

What am I missing?  I may add a few items based on comments.

What if cherry pie could cure cancer?

[After reading this post, please check out my related Econlog post, an increasingly rare example (for me) of a post where I discuss a NEW IDEA for monetary policy. At least new to me.]

Imagine a world where eating lots of cherry pie was bad for healthy people.  (Not hard to do.)  Now imagine that for some strange reason the consumption of cherry pie improved the health of cancer sufferers.  And the more you eat, the quicker you get over your cancer.  A slice after every meal is good for cancer sufferers; adding an afternoon snack is even better.  Sweet!

This scenario is fanciful, but actually does describe one important aspect of monetary policy.

When LBJ became president in late 1963, the economy was in decent shape.  It was three years into an expansion and inflation was less than 2%.  But he couldn’t leave well enough alone, and a couple years later began pressuring the Fed to stimulate the economy.  The Fed responded with a massive purchase of government debt, which led to a rapid increase in the money supply.  The monetary base had risen from $33.4 billion to $44.3 billion between November 1945 and November 1963, but soared to $83 billion by November 1973—the Great Inflation was underway.  BTW, these purchases reduced the value of US government bonds, for those worried about “Cantillon effects”.

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Just as eating too much pie is bad for a healthy person, monetizing lots of debt is bad for a healthy economy.  It causes high inflation, which discourages saving and investment.

Oddly, when the economy is so unhealthy that interest rates have fallen to zero, printing money to buy back the public debt becomes a healthy policy.  The more you buy the better you feel.  And it’s also highly profitable, at least in most cases.  Of course it’s theoretically possible that you’d buy assets with a lower rate of return than cash, which earns zero.  But that’s unlikely.

Because eating lots of cherry pie has a bad reputation, lots of doctors would discourage their cancer patients from eating too much for fear they might get diabetes. Even if consuming cherry pie worked miracles for cancer patients, some doctors would keep recommending chemo and radiation.  As an analogy, certain mushrooms dramatically reduce depression in patients with terminal cancer, but many doctors refuse to recommend this enjoyable drug because . . . well . . . I’m not sure why.  Perhaps it’s our puritan instincts.

Even though QE is a miracle drug that helps a zero bound economy get better and usually leads to big profits for the government, our economic doctors warn against taking too much of this delicious medicine.  After all, QE is bad for healthy economies.  In their view it’s better to rely on fiscal stimulus, which not only is not profitable, it imposes trillion dollar losses on the Treasury.  We live in a world where the Very Serious People tell us we need economic equivalent of chemo, not cherry pie.  Even though cherry pie is far tastier, and more effective.


PS.  Kevin Erdmann has a new piece in the Wall Street Journal.  Also, please order his excellent new book on housing, it will lead you to completely rethink many of your views of what happened during the boom and bust.



What should we expect from Fed officials?

I occasionally see comments from people who have an unrealistic set of expectations for Fed officials.

An institution like the Fed will tend to reflect the consensus view of economists. Back in late 2008, I was among perhaps a few dozen people in the entire world who blamed the Great Recession on a tight money policy of the Fed. Even today, that view is only slightly more popular, mostly due to the effort of market monetarist bloggers. It’s entirely unrealistic to expect Fed officials to reflect the views of market monetarists—that’s now how our system works. Nor will they reflect the views of other obscure groups, like MMTers or fans of the fiscal theory of the price level. That’s why I favor NGDP level targeting, it’s a regime that will lead to pretty good results under almost any competent leadership.

I’m not saying the people appointed to the Fed don’t matter at all. Bernanke did better than Volcker or Greenspan would have done (based on their public comments during the Great Recession), and better than the average economist would have done. Mario Draghi did better than Trichet. But for the most part, Fed policy merely reflects the consensus view of economists and financial market pundits. Don’t expect anything more than that.

David Beckworth recently interviewed Neil Irwin, who pointed out that Bernanke was under a lot of pressure to adopt a more contractionary policy.  He also noted that while Trump has criticized the Fed for raising rates, he has also appointed Marvin Goodfriend to the Fed, a relatively hawkish economist.  Obama also appointed several people who were more hawkish than Bernanke.  If Trump wants dovish policies then he might try appointing doves.

Over at Econlog, I have a “Ted talk” on the future of money.