A surprisingly conservative critique of the Fed by 22 “liberal” economists.

For several days I’ve been reading about a letter by 22 “liberal” (i.e. left-of center) economists, calling for a higher inflation target.  That’s not really my first choice, although I do see their point.  When I finally read the letter I was pleasantly surprised by its tone, which was quite moderate:

Even if a 2 percent inflation target set an appropriate balance a decade ago, it is increasingly clear that the underlying changes in the economy would mean that, whatever the correct rate was then, it would be higher today. To ensure the future effectiveness of monetary policy in stabilizing the economy after negative shocks – specifically, to avoid the zero lower bound on the funds rate – this fall in the neutral rate may well need to be met with an increase in the long-run inflation target set by the Fed.

As you know, I favor NGDP targeting.  But let’s suppose that we decided back in the early 2000s on a 4.5% NGDP target, expecting it to deliver 1.5% trend inflation.  Today we’d expect that same NGDP target to deliver roughly 3% inflation.  So in that sense they are correct—if we must target inflation, then due to changing circumstances a higher rate would now be appropriate.

There is another sense in which they are also correct.  The original call for a 2% target, instead of say 1% or zero, was partly based on the assumption that 2% was high enough to keep us away from the zero interest rate bound.  Japan had a zero percent inflation target, and was persistently at or close to the zero bound.  So if that was the criterion used for the 2% target in the early 2000s, then the exact same criterion would call for a higher target rate today.

And their concluding recommendations are quite modest and reasonable:

Policymakers must be willing to rigorously assess the costs and benefits of previously-accepted policy parameters in response to economic changes. One of these key parameters that should be rigorously reassessed is the very low inflation targets that have guided monetary policy in recent decades. We believe that the Fed should appoint a diverse and representative blue ribbon commission with expertise, integrity, and transparency to evaluate and expeditiously recommend a path forward on these questions. We believe such a process will strengthen the Fed as an institution and its conduct of monetary policy, and help ensure wise policymaking for the years and decades to come.

Isn’t the Congressional GOP proposing a similar commission?

The title of this blog post might seem a bit provocative, but that’s not my intention. These 22 left-of-center economists have signed a letter calling for the Fed to make its policy regime so robust that fiscal stimulus is no longer needed, indeed is no longer even effective. That’s effectively a “conservative” outcome.  I’m not sure that’s what they all intended—presumably people like Joe Stiglitz did not have that intention—but fiscal policy becomes superfluous when the Fed is not stuck at the zero bound (as we learned during the 1984-2007 period).  That’s not just my view, Paul Krugman used to make much the same argument.

If I wrote the letter it would have been much shorter:

Dear Fed, Please choose one of the half dozen policy regimes that insure monetary policy is always capable of providing the desired level of aggregate demand, so that fiscal stimulus is never needed.

PS.  I also have an Econlog post on Fed policy.

PPS.  At the half time of game 4, Paul Pierce had a look of wonder in his eyes.  Referring to Cleveland’s 86 points at the half, he said something to the effect, “My reaction is that’s what it takes to beat the Warriors?”  If the public understood just how small an adjustment it would take to fix monetary policy they have the opposite reaction: “That’s all it would have taken to prevent the Great Recession?”  The policy elite better hope the public never finds out.




16 Responses to “A surprisingly conservative critique of the Fed by 22 “liberal” economists.”

  1. Gravatar of flow5 flow5
    12. June 2017 at 15:29

    Pierce was the best basketball player to come out of KU. He was virtually the only player to part the zone and drive to the basket (either to shoot or dish the ball back out). But all you economists have it backwards.

    If the Fed hikes rates, look for an entry point to sell equities short. Look what the past rate hikes did:


    “The credit impulse in the US has also turned down, seemingly on the back of a sharp drop in demand for C&I loans. The slowdown is more visible in the bank loan data than the Flow of Funds data we are using to calculate the credit impulse (the FoF is 3x as broad and includes non-bank credit as well). But the slowdown is nonetheless at odds with confidence being expressed about investment and future borrowing plans. The US credit impulse was running at 0.7% GDP back in September 2016 and by March had fallen to -0.53% GDP (recovering somewhat in April based on bank loan data).”

    As I repeatedly said:

    “The economy is behaving exactly as it is programmed to act. Raise the remuneration rate and in a twinkling, the economy subsequently suffers. The Fed’s 300 Ph.Ds. in economics don’t know the differences between money and liquid assets. Apr 28, 2016. 11:25 AMLink

    I.e., contrary to Ben Bernanke, money is not fungible. One $ is not like any other (including E-$s).

    In “The General Theory of Employment, Interest and Money”, John Maynard Keynes’ opus “, pg. 81 (New York: Harcourt, Brace and Co.), gives the impression that a commercial bank is an intermediary type of financial institution (non-bank), serving to join the saver with the borrower when he states that it is an “optical illusion” to assume that “a depositor & his bank can somehow contrive between them to perform an operation by which savings can disappear into the banking system so that they are lost to investment, or, contrariwise, that the banking system can make it possible for investment to occur, to which no savings corresponds.”

    In almost every instance in which Keynes wrote the term bank in the General Theory, it is necessary to substitute the term non-bank in order to make Keynes’ statement correct.

  2. Gravatar of flow5 flow5
    12. June 2017 at 16:04

    Sumner: “Textbook monetary theory suggests that the Fed directly impacts short-term rates, and affects long-term rates by influencing the expected rate of NGDP growth.”

    No, that’s not how monetary policy works. Interest is the price of loan-funds, not the price of money. The price of money is the reciprocal of the price-level. By using the wrong criteria (interest rate manipulation), rather than member bank legal reserves in formulating and executing monetary policy, the Federal Reserve the Fed has lost control of both money, and the economy.

    Money and money flows are robust. But contrary forces are at work. An increase in IBDDs destroys money velocity. Hiking the remuneration rate destroys money velocity.

    Economists simply don’t understand the differences between money and liquid assets. Lending by the DFIs is infllationary. Lending by the NBFIs is non-inflationary, other things equal.

    All commercial bank-held savings are idle, un-used and un-spent. Bank-held savings are lost to both consumption and investment.

    All voluntary savings originate within the commercial banking system. And savings are never transferred out of the commercial banking system unless currency is hoarded or savings are converted to other national currencies. However, monetary savings are never activated and put back to work (completeing the circuit income velocity of funds), unless they are directly or indirectly funneled, by their owners, through non-bank conduits.

    From the standpoint of the system, the monetary savings practices of the public are reflected in the velocity of their deposits and not in their volume. Whether the public saves, dis-saves, chooses to hold their savings in the commercial banks or to transfer them to a non-bank will not, per se, alter the total assets or liabilities of the commercial banks, nor alter the forms of these assets and liabilities. The commercial banks could continue to lend even if the non-bank public ceased to save altogether.

  3. Gravatar of Benjamin Cole Benjamin Cole
    12. June 2017 at 16:22

    Yes an inflation band target would probably work better. Perhaps 2.25% to 3.25%.

    The fetish for low inflation rates is one of orthodox macro economics’ most annoying features.

  4. Gravatar of flow5 flow5
    12. June 2017 at 16:43

    You can call the 22 advocates of higher inflation targets stagflationists. And anyone who advocates targeting N-gDp stagflationists, where real-output is capped and inflation is maximized.

    The Golden Era in U.S. economics was where savings were “put to work” by the thrifts (which back then were non-banks) – making a direct contribution to labor and materials, expanding everyone’s incomes, making home ownership affordable, i.e., residential real-investment). There is currently a short-fall, relative to need, in new housing starts. And back then the FSLIC guaranteed the pooled deposits of the S&Ls.

    Everything began to change in January 1957 when the FDIC and the BOG began hiking Reg. Q ceilings for exclusively the banksters. And the FDIC also induced non-bank dis-intermediation by hiking insurance deposit coverage.

    Nobel Laureate Dr. Milton Friedman was “dimensionally confused”. He pontificated that: “I would (a) eliminate all restrictions on interest payments on deposits, (b) make reserve requirements the same for time and demand deposits”. Dec. 16, 1959.

    From the standpoint of the entire system, commercial banks never loan out, & can’t loan out, existing funds in any deposit classification (saved or otherwise), or the owner’s equity, or any liability item. Every time a DFI makes a loan to, or buys securities from, the non-bank public, it creates new money – demand deposits, somewhere in the system. I.e., deposits are the result of lending and not the other way around. The NBFIs are the DFI’s customers. The NBFIs are not in competition with the DFIs.

    “In a letter of March 15, 1981, Willis Alexander of the American Bankers Association claims that: ‘Depository Institutions have lost an estimated $100b in potential consumer deposits alone to the unregulated money market mutual funds.’ As any unbiased banker should know, all the money taken in by the money funds goes right back into the banks, in the form of CDs or bankers acceptances or other money market instruments; there is no net loss of deposits to the banking system. Complete deregulation of interest rates would simply allow a further escalation of rates by the banks, all of which compete against each other for the same total of deposits.”

    Written by Louis Stone whom the movie “Wall Street” was dedicated to – Vice President Shearson/American Express

  5. Gravatar of Rajat Rajat
    12. June 2017 at 18:10

    “If the public understood just how small an adjustment it would take to fix monetary policy…”

    Is it so straightforward? Maybe technically, if you subscribe to the NK model and nothing else. But few are this pure.

    Even though Australia has never being at or close to the ZLB, our central bank head, Philip Lowe, seems determined to not lower the official cash rate (presently 1.5%), despite inflation and wages growth well below target. The latest monthly meeting statement, effectively said as much: https://www.rba.gov.au/media-releases/2017/mr-17-12.html

    Why? Could it be that Lowe wrote a paper with the present head of the RBA economics team in 1998 warning against housing bubbles (https://t.co/T8igcXw0ik) and one with Claudio Borio of the BIS in 2002 along similar lines (http://www.bis.org/publ/work114.htm)?

    Here is an extract of the 1998 paper:

    Monetary policy can burst property-price bubbles. Under some circumstances, it may make sense to do so, even if it means that expected inflation is below the central bank’s target. The case for attempting to influence equity prices is weaker than for property prices.
    Monetary policy can burst bubbles in property prices by increasing the cost of speculative behaviour and by slowing down the growth rate of economic activity. If the only instrument of policy is short-term interest rates, a protracted period of tight policy is probably required. This means that when the bubble bursts, losses are likely in the financial system and economic growth is likely to be below trend. But once a bubble has emerged, avoiding such an outcome will prove even more difficult. By bringing forward the collapse of the bubble, monetary policy can reduce the scale of the inevitable slowdown in economic activity. The main difficulties with such a policy are in identifying that a bubble does indeed exist and generating the necessary public acceptance of a period of tight monetary policy

    Not saying Australia is about to fall into a recession, but I would say it’s at greater risk of doing so now with the present RBA head – even with its 2-3% inflation target – than any time since the financial crisis.

    If the Fed’s target were raised to 4%, but certain FoMC members were more concerned about low rates causing bubbles, the same could happen.

  6. Gravatar of Rajat Rajat
    12. June 2017 at 18:33

    I should add that Lowe received his PhD from MIT in 1991 and Lowe’s 1998 co-author, Chris Kent, got his PhD from MIT in 1997, so they both have the sort of elite mainstream pedigree that one would expect from modern central bankers.

  7. Gravatar of ssumner ssumner
    13. June 2017 at 05:15

    Rajat, I absolutely agree that recessions are possible, even when not at the zero bound. Indeed the US had recessions in 1990 and 2001, despite not being at the zero bound.

    And we were already in recession during 2008, before hitting the zero bound.

    But I do think the Fed’s failure to properly handle the zero bound largely explains the “greatness” of the Great Recession.

  8. Gravatar of Benjamin Cole Benjamin Cole
    13. June 2017 at 06:38

    Egads, take a look at the Kent-Lowe paper cited by Rajat


    This is a paper on the need for central banks to pop property price bubbles, even if it means tanking the economy and knifing the financial system…because if a central bank waits, it will get worse.

    The words “property zoning” are entirely absent from the paper.

    What is about property zoning that blinds macroeconomists?

    How could property bubbles exist if property zoning were phased out?

    Does the present advised monetary policy procedures of

    1) occasionally popping property “bubbles” and bringing about a 2008,

    or 2) suffocating economies on a continuous basis to avoid a property “bubble”

    make sense?

    How is it two highly intelligent people, Kent-Lowe, could write about property appreciation and bubbles without using the words “property zoning”?

    Not even in a footnote.


  9. Gravatar of Matthew Waters Matthew Waters
    13. June 2017 at 10:05

    Yeah, just from what Rajat quoted, that paper is terrible.

    I don’t understand how this Austrian Business Cycle idea has always permeated central banks. It goes back to 1928 “taking away the punch bowl.” Now, the WSJ link in the Econlog post says that the Fed needs to “cool off Wall Street’s hot streak.”

    Austrian theory posits markets are simultaneously efficient and non-efficient and non-efficient. Markets are extolled above all else, but markets get tricked by loose monetary policy. Well, are markets efficient or aren’t they?

    The next question is: Even if we stipulate markets are tricked by low rates, so what? The responsibility of losses for both the dot-com bubble and housing bubble lie with the end investors. Why should the Fed protect investors from themselves?

    But “taking away the punch bowl” clearly has strong resonance with central bankers going back decades. I don’t understand why.

  10. Gravatar of Benjamin Cole Benjamin Cole
    13. June 2017 at 15:45

    Mathew Waters–
    The answer to central banker behavior is not found in economics but rather in sociopathology.

  11. Gravatar of Rajat Rajat
    13. June 2017 at 17:07

    Thanks Scott. I suppose I am concerned about a Great Recession repeat just in Australia due to overly tight policy. While you often refer to the 1990-91 recession in the US as mild and no more than a hiccup in America’s Great Moderation, it was quite serious in Australia, with unemployment rising to over 10%. There was no inflation target back then, but we did have stubborn monetary policy-makers who ignored market signals. I’m concerned the same could happen again.

  12. Gravatar of Postkey Postkey
    14. June 2017 at 02:39

    “Textbook monetary theory suggests that the Fed directly impacts short-term rates, and affects long-term rates by influencing the expected rate of NGDP growth.”

    ‘Textbook monetary theory’ is ‘wrong’?

    “ . . . In fact, among the more than 10,000 research articles produced by the major central banks in the two decades prior to the 2008 crisis, none explored the correlation or causation between nominal interest rates and nominal GDP growth. Fortunately, this task is not very demanding, and once we conduct such an examination, we conclude that, in actual fact, there is no evidence to back these assertions whatsoever. To the contrary, empirical evidence shows that the central banking narrative on interest rates is diametrically opposed to the observable facts in two dimensions: instead of the proclaimed negative correlation, interest rates and economic growth are positively correlated. Secondly, the timing shows that interest rates do not move ahead of growth, but instead are either coincidental or even follow it.”

  13. Gravatar of flow5 flow5
    14. June 2017 at 06:51

    That study is back asswards (indeed dubious). And it wasn’t the “first”.


    That’s not how to differentiate between money creating depository institutions from financial intermediaries (conduits between savers and borrowers), i.e., perform double-entry book-keeping on a national scale.

    Professional economists have no excuse for misinterpreting the savings investment process. They are paid to understand & interpret what is happening in the whole economy at any one time. For the commercial banking system, this requires constructing a balance sheet for the System, an income & expense statement for the System, & a simultaneous analysis of the flow of funds in the entire economy.

    The expansion of bank credit & new money by the DFIs can be demonstrated by examining the differences in the consolidated condition statements for the banks & the monetary system at two points in time.

    Increases in the DFI’s loans & investments/earning assets/bank credit, are initially approximately the same as increases in transaction accounts, & time (savings) deposits, TDs, liabilities (“bank credit proxy”). That the net absolute increase in these two figures is so nearly identical is no happenstance, for transaction deposits, TRs, largely come into being through the credit creating process, & time deposits, TDs, owe their origin almost exclusively to TRs.

    There are many factors, which can, & do, alter the volume of bank deposits, including: (1) changes in currency held by the non-bank public, (2) in bank capital accounts, (3) in reverse repurchase agreements, (4) in the volume of Treasury currency issued & outstanding, & (5) in Reserve Bank credit. Although these principle items are largest in aggregate, they nevertheless have been peripheral in altering the aggregate total of bank deposits.

  14. Gravatar of flow5 flow5
    14. June 2017 at 07:09

    Werner: “We can decentralize power in our monetary system by abandoning the big banks and instead creating and supporting local not-for-profit community banks”

    This is in fact correct. And so is Ellen Brown’s Public banking. We can, if we want, go back to the days when a savings account was just that – and not an adjunct to our checking accounts.

  15. Gravatar of Julius Probst Julius Probst
    15. June 2017 at 01:42

    Hi Scott,

    unrelated to this post. You maybe want to have a look at this WaPo article by Larry Summers. First time I think he has put down in black and white that he favors NGDP level targeting. Also the entire article sounds very market monetarist. He points out to the extreme difference between market forecasts of future interest rates and the Fed’s own internal forecasts, just FYI.

    “I suspect, for reasons I will write about in the next few days, that moving away from inflation targeting to something like nominal gross domestic product-level targeting would be a better idea.”

    Here the link:

  16. Gravatar of ssumner ssumner
    15. June 2017 at 05:20

    Rajat, That’s possible, but recall that 1991 was associated with a big drop in inflation. (BTW, I was living in Australia at that time.)

    Postkey, You said:

    “instead of the proclaimed negative correlation, interest rates and economic growth are positively correlated.”

    That’s what the textbooks say.

    Thanks Julius, I’ll probably do a post on that at Econlog or over here.

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