Complacency

I recently listened to David Beckworth’s interview with Tim Duy.  Tim is one of most talented Fed watchers, and had a number of astute observations about the way the Fed communicates.  At one point David was asking why the Fed seemed to be behind the curve in 2008.  Duy said something to the effect that the Fed hadn’t expected to encounter a situation like that, and wasn’t quite ready to deal with the need for policy alternatives at the zero bound.  (Not his exact words.)

I think that’s probably right, but it’s interesting to think about why the Fed was not better prepared for 2008.

According to Lawrence Ball, Bernanke came to the Fed with pretty well formed ideas of how to deal with a liquidity trap.  Indeed that’s why I was so pleased when Bernanke was picked. But at an early meeting (in 2003), his views on policy options at the zero bound were dismissed or ignored by the Fed policy establishment.  According to Ball, after that meeting Bernanke mostly adopted the policy options of that establishment, not the options that Bernanke had previously recommended to the Japanese.

So why was the Fed so complacent?  I’m not sure the answer, but I do believe that this is a key question for the Fed going forward.  I’m convinced that there were alternative monetary policy options (such as NGDPLT) that would have led to a much milder recession.  But what does the Fed think?  Here are 4 options:

1.  By 2008, nothing could have prevented a severe recession, even with 20/20 hindsight.

2.  By 2008, a severe recession could only have been prevented by switching to a different regime, such as price level targeting or NGDP level targeting.  And the Fed is not willing to make that switch.

3.  By 2008, a severe recession could have been prevented by being much more aggressive with existing tools such as cutting rates sooner, doing QE sooner and more aggressively, and doing more aggressive forward guidance.  No regime change was needed.  But the Fed had no way of knowing (in 2008) that this sort of aggressive policy response was appropriate.

4.  By 2008, a severe recession could have been prevented being much more aggressive with existing tools such as cutting rates sooner, doing QE sooner and more aggressively, and doing more aggressive forward guidance.  No regime change was needed.  And the Fed could have seen the need for this if they had focused on NGDP forecasts rather than inflation, or perhaps if they had focused on TIPS spreads rather than past inflation rates.

I believe that #1 and #3 are false, and #2 and #4 are true.  But what does the Fed believe?  It would be nice if the Fed put together a report on what sort of policy would have been appropriate, in retrospect, during 2008.  The report should also discuss whether enough has been learned so that the same mistakes would not be made, should we ever face a similar situation.

PS.  While the Fed has been too complacent about the risks posed by the zero bound, the voters of LA have been exactly the opposite—rejecting complacency by an overwhelming margin:

Angelenos on Tuesday resoundingly voted down a ballot measure aimed at limiting the construction of big, tall buildings in the city of Los Angeles.

Measure S—an initiative supported by residents frustrated with large-scale development—took a beating at the polls, winning just 31.15 percent of votes, when it needed a majority to pass.

Launched and funded primarily by the nonprofit AIDS Healthcare Foundation, the measure would have placed a two-year moratorium on buildings that did not conform with the city’s outdated General Plan, which is like the bible for zoning and land-use.

So it seems the public actually opposes NIMBYism, it’s the special interest groups that support it.

Or more specifically one special interest group:

With city elections rapidly approaching, the AIDS Healthcare Foundation continues to pour money into Measure S, contributing nearly $3 million since the start of the year.

In the first three weeks of the year, the foundation poured $300,000 into the campaign, then it funneled $1.95 million to the campaign in the three weeks from January 22 to February 18. The latest filings show it has since given another $600,000.

The AIDS Healthcare Foundation has been the main backer of the March 7 ballot measure since its inception in November 2015. If passed by voters, Measure S would put a two-year moratorium on all development projects requiring zoning or height changes or adjustments to the city’s General Plan.

Numerous individual donors have also kicked in small contributions to the Measure S campaign—but more than 99 percent of the money raised during that three-week period came from the foundation.

99 percent?  Who knew?

After my Trump posts, I feel I’ve completely run out of sarcasm.  Let’s see what commenters can come up with here.

 


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31 Responses to “Complacency”

  1. Gravatar of Michael Michael
    13. March 2017 at 23:41

    > But what does the Fed believe?
    Very good question, and I really do hope you can draw some answers out of the Fed
    Actually, it’s a very good management technique to do a pretend ‘post mortem’ even BEFORE a project under the assumption “we’re in a mess. what did go wrong?”. Amazing how much can be anticipated if one allows oneself to.

    > I believe that #1 and #3 are false, and #2 and #4 are true.
    I guess you mean “#2 OR #4 are true” — can’t be both

  2. Gravatar of Francois Francois
    14. March 2017 at 03:22

    I have been closely watching monetary policy since 2010. Unlike 99.9% of Europeans, I understood by August 2011 that the Euro crisis was in fact an unwarranted monetary contraction. When I pointed out the collapse of inflation breakevens across Europe in 2011, my colleagues were laughing me out.

    Back to your post … For me, the key issue is first and foremost whether Fed policymakers would have been able to see in a timely manner the passive tightening of monetary conditions that was taking place at the time. I guess that inflation breakevens for example should have shown something, but that needs to be checked. If they couldn’t clearly see the tightening of monetary conditions in real time, then it is not worth discussing what they could do about it.

  3. Gravatar of Luis Pedro Coelho Luis Pedro Coelho
    14. March 2017 at 03:39

    The AIDS Healthcare Foundation???!!

    Of all the interest groups that I thought could oppose high density housing, the AIDS Healthcare Foundation would not be in my list of the top 1,000.

  4. Gravatar of Francois Francois
    14. March 2017 at 03:40

    If Fed policymakers could see the tightening of monetary conditions, then …
    #1 is obviously false.
    #2 is false. Even tough I am entirely supportive of a NGPLT regime, I think it was possible to loosen monetary conditions within the existing regime at that time.
    #3 is false. There was still room for cutting rates in early 2008. Bernanke had already suggested QE for Japan. No reason for me to believe that the Fed thought these tools were not appropriate.
    #4 seems correct to me.

  5. Gravatar of JMCSF JMCSF
    14. March 2017 at 04:45

    The guy in charge of AIDS Healthcare Foundation is a peice of work. There is a two tower project going up in Hollywood next to his office (he is in the 22nd floor of his office building). So he is supposedly upset about that.

    He is also the person who stigmatizes one of the most effective HIV-prevention medications and fought against its approval and use.

    A totally disgusting hypocrite.

  6. Gravatar of Ray Lopez Ray Lopez
    14. March 2017 at 04:50

    Poor Scott, he’s stuck on 2008. Like the hippies in 1969 and like Taylor Swift’s album “1989”. I guess Sumner thinks that had the Fed loosened more a few months in 1989, we’d not have an output gap with potential GDP now. Sumner thinks the economy is so ‘path-dependent’ that what happens in a few months nearly ten years ago determines the state of the economy for decades. If he’d read GM Rogoff’s book “This Time”, he’d know different. All the stats for the USA since the financial crisis, like unemployment drops, like Fed govt deficit rises, like numbers working, have mimicked the averages in Rogoff’s book, and even the ‘drawdown’ (peak-to-trough-back-to-peak) for many stats has been about average: about 6 years, with a maximum of 20 years.

    It’s 2017 Professor Sumner, not 2008. Time to come out of the cold. The war is over, you can surrender now, it’s OK.

  7. Gravatar of Christian List Christian List
    14. March 2017 at 05:19

    How is that not an illegal misappropriation of donations?! I thought America is the land of lawsuits. Why is this guy not in jail already? What is Weinstein financing next? His maserati? Reminder: Never donate any money to institutions like this. What a fraud.

  8. Gravatar of rayward rayward
    14. March 2017 at 05:22

    Complacency. Sumner’s colleague Tyler Cowen has written a book that identifies complacency as the source of our troubles. Probably not. Larry Summers identified complacency as the source of the financial crisis in his Okun Lecture given as the crisis was unfolding. Complacency? Yes, as in the Fed was too complacent about misleading inflation data (missing the bubble that was hard to miss), smart economists like Summers having solved the Phillips Curve dilemma. If Summers (Summers!) could believe that, so could Bernanke and others at the Fed. Of course, Summers has long since changed his view about the financial crisis. And I’d be the first to admit that I’ve come out of the gate with what turned out to be wrongheaded ideas. My point is that economists (people) are much better at predicting the past than in predicting the future.

  9. Gravatar of Sean Sean
    14. March 2017 at 10:34

    We had the huge ramp in oil prices in the summer of 2008. I think the fear of inflation that put into the FED is a vastly underrated cause of the crisis. I think banks were overleveraged and that was like tinder for a monetary policy mistake, but the oil boom (largely from china ramping up inventories and being pre-shale) was the match.

  10. Gravatar of Patrick R. Sullivan Patrick R. Sullivan
    14. March 2017 at 10:37

    Tim Congdon and Steve Hanke appear to be as big fans of the President of the Minneapolis Fed as I am;

    https://www.wsj.com/articles/more-bank-capital-could-kill-the-economy-1489446254

    ‘What might happen if the Trump administration enacted [Neel Kashkari’s] plan? Bank stocks would take another dive. They would find it impossible to raise new capital through equity or bond issues, so they would be forced to shed assets. As in 2009 and 2010, banks would refuse applications for new loans. They might go so far as to wriggle out of contracts for existing loans and ask for early repayment.

    ‘Unless the Fed would buy up assets far in excess of the previous three “quantitative easing” exercises, the quantity of money in the economy would fall and the traumatic economic conditions of the Great Depression and Great Recession would return.’

  11. Gravatar of Patrick R. Sullivan Patrick R. Sullivan
    14. March 2017 at 12:14

    Trumphobia has kept me away from my Bernanke-monitoring, I see;

    https://www.brookings.edu/blog/ben-bernanke/2017/01/26/shrinking-the-feds-balance-sheet/

    ————–quote————
    Prior to the crisis, the Fed set short-term interest rates through open-market operations that varied the quantity of bank reserves in the system, a technique which involved on average low levels of reserves—perhaps $10 billion or so. Today, the level of bank reserves is much higher, which makes it impossible to manage interest rates through small changes in the supply of reserves. Instead, the Fed manages short-term interest rates by setting certain key administered interest rates, such as the rate it pays bank on reserves held with the Fed. This “floor system” (called that because rates like the interest rate on bank reserves set a floor for the policy rate) was adopted out of necessity but seems to be gaining favor with the FOMC as a better way to manage monetary policy. According to the November 2016 minutes, FOMC participants described the current floor system as “relatively simple and efficient to administer, relatively straightforward to communicate, and effective in enabling interest rate control across a wide range of circumstances.”

    What level of bank reserves would be needed for the Fed to continue to implement monetary policy by current methods? To ensure that the floor rate set by the central bank is always effective, the banking system must be saturated with reserves (that is, in the absence of the interest rate set and paid by the central bank, the market-determined return to reserves would be zero). In December 2008, when the federal funds rate first fell to zero and the Fed began to use the interest rate on bank reserves as a tool of monetary policy, bank reserves were about $800 billion. Taking into account growth in nominal GDP and bank liabilities, the critical level of bank reserves needed to implement monetary policy through a floor system seems likely to be well over $1 trillion today, and growing. Taking currency demand into account as well, it’s not unreasonable to argue that the optimal size of the Fed’s balance is currently greater than $2.5 trillion and may reach $4 trillion or more over the next decade. In a sense, the U.S. economy is “growing into” the Fed’s $4.5 trillion balance sheet, reducing the need for rapid shrinkage over the next few years.
    —————endquote—————–

  12. Gravatar of dtoh dtoh
    14. March 2017 at 13:37

    1. It was 100% obvious that the economy was tanking just by looking at the equity and other asset markets.

    2. Any or no policy target would have been fine. The Fed nearly needed to stomp hard on the gas (i.e. buy a lot more financial assets from the non-banking sector.)

    3. Bernanke knew all this but was unable to get the Fed to change direction because academics are incompetent and inexperienced at any undertaking which requires interaction with other human beings.

    4. The Fed doubly screwed the pooch by buying a lot of assets (excess reserves) from the banking sector, thereby undermining the credibility of and belief in the efficacy of Fed action for probably a generation.

  13. Gravatar of Matthew Waters Matthew Waters
    14. March 2017 at 13:43

    IMO, a big part is Bernanke didn’t really set policy but the FOMC did. I know the FOMC had uber-hawk Fisher on it and it was considered tactless to have an FOMC split. In the minutes, Fisher always thought hyper-inflation was right around the corner because he paid more for dry cleaning or a hot dog or whatever.

    I also do not think the question is orthogonal to the AIG and TARP bailouts and the commercial paper facility. IMO, it’s *very* hard to say exactly what would have happened under the following scenario:

    1. The Fed/Treasury did not have the AIG bailout or TARP.
    2. The commercial paper facility was not introduced. Nor was the expansion of acceptable collateral for the discount window.
    3. But the Fed did aggressively put in place QE and forward guidance. However, the QE would ONLY be for risk-free assets.

    Should AIG have failed, I just do not see the risk-free QE/forward guidance being enough. I think that’s what Bernanke also thought, at least at the time of the banking panics. The “helicopter drop” paper was about fiscal policy, where the actual helicopter drop is done by lowering tax rates until demand recovers.

    Either risky asset purchases or significant negative rates needed to be on the table for pure monetary policy to have worked after Lehman’s failure.

  14. Gravatar of Christian List Christian List
    14. March 2017 at 13:44

    Isn’t Tyler Cowen a utilitarian as well? If so his book is a bit odd. One of the main goals of utilitarianism seems to be happiness. But then as soon as people are finally happy, Tyler Cowen seems to complain that they are “complacent.”.

  15. Gravatar of Liberal Roman Liberal Roman
    14. March 2017 at 14:36

    I wouldn’t get too excited about Measure S failing. Yes, blanket moratorium don’t do well at the polls. That’s so blatantly anti-development, people are too ashamed to vote for it I am guessing. One failed in San Francisco couple years ago http://www.sfgate.com/bayarea/article/Moratorium-on-new-Mission-District-housing-is-6609187.php

    But don’t worry NIMBYs, your traditional tactics of targeting and killing off specific projects one by one is still a winner. So is requiring absurdly high affordability requirements for projects so as to make them not viable. Sorry, as a cynical YIMBY, it’s hard to get too excited at this one victory.

  16. Gravatar of ssumner ssumner
    14. March 2017 at 15:41

    Michael, Good catch, it can’t be #2 and #4. I was thinking that the last sentence in point #2 was true and the last sentence in point #3 was false.

    Francois, You said:

    “When I pointed out the collapse of inflation breakevens across Europe in 2011, my colleagues were laughing me out.”

    I feel your pain. And I’d guess these were the same idiots that in 2014 and 2015 were saying the ECB was out of ammunition.

    On your second point, that’s why we desperately need a highly liquid NGDP futures market.

    And yes, I think #4 is true, see my reply to Michael.

    JMCSF, Does anyone actually donate money to that organization? And if so, why?

    Sean, I agree that the oil shock was a factor. So what have they learned from that?

    dtoh, The Fed didn’t buy lots of ERs from the banking system.

    You said:

    “Bernanke knew all this but was unable to get the Fed to change direction because academics are incompetent and inexperienced at any undertaking which requires interaction with other human beings.”

    Better to rely on business people like Herbert Hoover, Carter, Bush, Trump, etc.

    Liberal Roman, As I said, the problem isn’t voters, it’s special interest groups. So I’m certainly not expecting this victory will stop NIMBYism.

  17. Gravatar of dtoh dtoh
    14. March 2017 at 16:05

    Scott,
    Correct. They bought lots of assets in exchange for ER.

  18. Gravatar of Benjamin Cole Benjamin Cole
    14. March 2017 at 16:15

    I read somewhere that the self-confident Fedster Vincent Reinhart became very influential with the scholarly perhaps timid Bernanke. Reinhart went on from the Fed to Wall Street and the AEI.

    All public agencies tend to ossify and become self-reverential. The Fed too.

  19. Gravatar of Anand Anand
    14. March 2017 at 17:32

    It’s a weird situation. Seems to me like the Foundation’s quixotic position isn’t shared by many others:

    “The [AIDS Healthcare] foundation’s hefty donations haven’t matched what groups opposing the measure have raised.

    The two groups fighting Measure S have amassed more than $4.5 million in donations since the start of the year, campaign filings show.

    That money has come from a wide array of donors, including labor unions, trade associations, and prominent developers such as Westfield and Crescent Heights, which is building a pair of towers behind the Hollywood Palladium.”

  20. Gravatar of dtoh dtoh
    14. March 2017 at 19:09

    Scott,
    The issue is not Nimbyism. The problem is arbitrary and inconsistent rules.

    Some land uses involve externalities. This has been recognized for centuries, and why land ownership conveys not unlimited rights but only a limited bundle of rights as to how the land is used. I.e. you can’t operate a smelly pig farm in a suburban area.

    The problem is when the rights and limitations are not clear or are not consistently applied so that influential developers can bend the rules to permit projects that would not otherwise be allowed or conversely when residents block projects that should be allowed.

  21. Gravatar of Dtoh Dtoh
    15. March 2017 at 16:18

    “Better to rely on business people like Herbert Hoover, Carter, Bush, Trump, etc.”

    I would rely on business executive not a business person.

    And BTW….to what do you attribute Bernanke’s utter failure as Fed Chair.

  22. Gravatar of Anonymous Anonymous
    15. March 2017 at 23:18

    After my Trump posts, I feel I’ve completely run out of sarcasm. Let’s see what commenters can come up with here.

    President Trump Leads a Roundtable with CEOs and Union Workers

    https://www.youtube.com/watch?v=R5Kl3DFEX0M

    Scott Sumner lacks the talent of Donald Trump.

  23. Gravatar of Anonymous Anonymous
    15. March 2017 at 23:27

    President Trump, speaking about 7th president Andrew Jackson, stated that Jackson “launched a campaign to sweep out government corruption, TOTALLY”…and…“he battled the centralised financial power that brought influence at our citizen’s expense

    https://www.youtube.com/watch?v=d2_3I9pabRo#t=5m27s

    PRESIDENT TRUMP IS GOING AFTER THE CORRUPT FEDERAL RESERVE

    Scott Sumner on suicide watch

  24. Gravatar of Anonymous Anonymous
    15. March 2017 at 23:43

    President Trump: https://twitter.com/realDonaldTrump/status/842229104434913280

  25. Gravatar of Anonymous Anonymous
    15. March 2017 at 23:45

    WOMEN FOR TRUMP

    https://i.redd.it/qtmnbqcweoly.jpg

  26. Gravatar of ssumner ssumner
    16. March 2017 at 05:39

    dtoh, I don’t agree, the problem is NIMBYism. Just because not all projects should be allowed, doesn’t mean NIMBYism is not a big problem.

    And I don’t think Bernanke was an “utter failure” as the Fed did far better than the ECB under similar circumstances.

    Anonymous, Thanks for helping me to find my sarcasm again. So, all the Goldman Sachs people filling up most of the key positions in Trump’s government are going to “go after” the Fed. I can’t wait!

  27. Gravatar of Anonymous Anonymous
    16. March 2017 at 16:09

    Scott Sumner, you cannot take down a powerful secretive institution like the Fed without having people who know how that institution works on your team. That is just basic strategy.

    If someone wanted to take down the CIA, it would be a wise decision to have ex-CIA agents advising you.

    The best part is that these people don’t even need to be ideologically aligned with you. They just to do their jobs and advise you how it works.

    Thoughts?

  28. Gravatar of dtoh dtoh
    16. March 2017 at 16:29

    Scott

    “And I don’t think Bernanke was an “utter failure” as the Fed did far better than the ECB under similar circumstances.”

    That’s “The youngest horse in the glue factory” argument.

    Honestly Scott, the reason the Fed gets away with such awful performance is because of apologists who are worried about their careers and reputation and don’t dare criticize Sir Ben and the monetary policy establishment.

    As for Nimbyism, that’s the way government works, we make collective decisions about what is and what is not allowed. The problem is when we permit extra-governmental processes that allow special interests to bypass the normal collective decision making process.

  29. Gravatar of Jacob Aaron Geller Jacob Aaron Geller
    18. March 2017 at 13:16

    I don’t understand… what does AIDS have to do with tall buildings?

    The AIDS Healthcare Foundation president’s stated reason — that Measure S is one their “social justice battles against governments that fail to serve the people” — clarifies nothing.

  30. Gravatar of ssumner ssumner
    20. March 2017 at 05:42

    Anonymous, Nice try, but I don’t think Cohn and Mnuchin are trying to “take down” the Fed.

    dtoh, You said:

    “Honestly Scott, the reason the Fed gets away with such awful performance is because of apologists who are worried about their careers and reputation and don’t dare criticize Sir Ben and the monetary policy establishment.”

    No, the reason he gets away with it is because the elite economists agree with Bernanke. I know these people, you don’t.

    I’m one of the few economists who think the Fed’s tight money policy of 2008 caused the recession. It’s not fear keeping the rest silent, it’s ignorance.

    And saying “that’s the way government works” doesn’t really tell me anything, does it? Obviously I know how it works.

  31. Gravatar of dtoh dtoh
    20. March 2017 at 15:49

    Scott,
    So Fed policy caused the 2008 recession which resulted in the loss of 10+ million jobs and multiple trillions of dollars of output in the U.S. alone, and that is not an utter failure?

    In you view, what would constitute an utter failure?

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