All hail Kocherlakota!

To put the following quote in perspective, let’s first summarize how the Fed views the world:

1.  The Fed successfully targets inflation at 2%.

2.  This can only occur if the Fed is able and willing to steer the nominal economy, i.e. NGDP.  So the path of NGDP is determined by Fed actions (or perhaps errors of omission.)

3.  Although the Fed believes it steers the nominal economy, it never takes the blame for bad outcomes, in real time. Later on it might admit that it caused the Great Contraction and Great Inflation (indeed it has admitted to those two crimes) but not in real time, not while it’s committing the crimes.  Thus in 2008-09 it did not admit that the failure to cut interest rates between April and October 2008 was a huge contractionary mistake.

4.  Instead, in real time the nominal economy is assumed to move of its own accord (even though the Fed’s model says they drive NGDP) and the Fed is a like a firefighter who comes in to rescue the economy, when it misbehaves.

But now we have Minneapolis Fed President Narayana Kocherlakota in the WSJ admitting that on a few occasions the Fed actually causes the fire.  And he’s admitting this in real time, not just that they were too contractionary when the sharply cut the base between October 1929 and October 1930, or too expansionary when they cut interest rates in 1967.  They are too contractionary right now.

I participate in the meetings of the Federal Open Market Committee, the monetary policy-making arm of the Federal Reserve. In that capacity, I’m often asked by members of the public about the biggest danger facing the economy. My answer is that monetary policy itself poses the biggest danger.

Many observers have called for the FOMC to tighten monetary policy by raising interest rates in the near term. But such a course would create profound economic risks for the U.S. economy.

Why would a near-term tightening of monetary policy be so problematic? Because given the prevailing economic conditions, higher interest rates would push the economy away from the FOMC’s economic goals, not toward them.

Congress has mandated that the Fed promote price stability and maximum employment. The FOMC has translated its price-stability mandate into a target 2% inflation rate, as measured by the personal consumption expenditures price index. Inflation has run consistently below that objective for more than three years and is currently at 0.3%.

The outlook is for more of the same. Most private forecasters do not see inflation reaching 2% for the next two years. Government bond yields are consistent with that same subdued inflation outlook. In June the FOMC’s own staff forecast was that inflation would remain below the committee’s 2% target until the 2020s.

The U.S. inflation outlook thus provides no justification for policy tightening at this juncture. Given that outlook, the FOMC should ease, not tighten, monetary policy by, for example, buying more long-term assets or by reducing the interest rate that it pays on excess reserves held by banks. Along these lines, the board of directors of the Minneapolis Fed has for the past few months been recommending a reduction in the interest rate that the Federal Reserve charges banks for discount window loans.

Now, this is not to say that increasing the federal-funds rate by a mere quarter of one percentage point, as many advise, would in and of itself have a huge direct impact on the U.S. economy. But even a small change toward tighter policy would send a strong message to financial markets.  [Emphasis added]

I’ve also said the Fed should cut rates now.  Indeed I’ve said just about everything Kocherlakota says here. How did Kocherlakota ever get appointed to the Fed? They need to screen candidates more carefully.

PS.  The 5-year TIPS spread has now fallen to 1.2%, and the 30-year is at 1.75%. Question, what’s the all-time low for the 30-year spread?

PPS.  So much for those who said the Fed wasn’t doing enough in 2013 and 2014 because of the zero rate bound.  They are about to raise rates!  But while many Keynesians were a little bit wrong they can at least point to the conservatives, who have been wrong about monetary policy so many years in a row it’s becoming almost comical.

HT:  Michael Darda



30 Responses to “All hail Kocherlakota!”

  1. Gravatar of Kevin Erdmann Kevin Erdmann
    20. August 2015 at 07:43

    Did you see the terrible paper from Williamson? I’ve already seen this referenced as “See! The Fed admits that QE was a sham!”

  2. Gravatar of Robert Robert
    20. August 2015 at 07:57

    Remembering the Kocherlakota interest rate controversy. Taking your point that under the gold standard, higher rates are inflationary because they increase velocity. Accepting the Keynesian point that the money supply is irrelevant at the zero bound. Then:

    Does the Keynesian claim mean we are therefore in a “gold standard-like” world, and that, if they are right, then Kocherlakota was also right that raising interest rates would be inflationary because it raises the velocity of money?

    I understand the argument that it is wrong because rising rayes are achieved by tighter money. What I am really asking is – was it inconsistent for Keynesians to argue that he was wrong and that market monetarists were also wrong?

  3. Gravatar of Samosale Samosale
    20. August 2015 at 08:02

    “all-time low” is a relative construct. What if the economy is in new lower ngdp equilibrium?

  4. Gravatar of Evgeny Evgeny
    20. August 2015 at 08:06

    What bothers me most is that despite such a clear and obvious failure to achieve one of the core mandates (inflation) for such a prolonged period of time there is close to zero institutional response. Moreover, simply pointing to the obvious as Narayana has done, already evokes a “hail the brave/genius” response.

    From my point of view, this proves yet again that the Fed is driven more by ideology in its decision making rather than any sensible macroeconomic logic. Not that I believe much is going to be done about it any time soon :(.

  5. Gravatar of Kevin Erdmann Kevin Erdmann
    20. August 2015 at 08:08

    Thinking about Robert’s question, is there a stock vs. flow issue here? It seems that the change in velocity would scale with the stock of excess reserves outstanding while the deflationary effect of raising IOR would be related to the flow of deposits into new reserves. Is there a level of excess reserves outstanding where the inflationary effect of higher velocity outweighs the deflationary effect of higher IOR?

  6. Gravatar of ssumner ssumner
    20. August 2015 at 08:37

    Robert, I guess you’d have to ask a Keynesian what they predict tight money would do to M and V. The model makes no sense to me, so I’m not the person to ask.

    Kevin, I’m not sure I follow your question. The level of V should be correlated with the level of nominal interest rates.

  7. Gravatar of ssumner ssumner
    20. August 2015 at 08:39

    Kevin, Now I see your point. When you raise IOR is reduces reserve velocity while it raises currency velocity. The net effect should be lower base velocity.

  8. Gravatar of Kevin Erdmann Kevin Erdmann
    20. August 2015 at 08:53

    Ah. Yes. I made an error, I think. The increase in velocity would come from the stock of currency, not the stock of reserves…

  9. Gravatar of Kocherlakota, the “turncoat”! | Historinhas Kocherlakota, the “turncoat”! | Historinhas
    20. August 2015 at 09:33

    […] “All hail Kocherlakota”, Scott Sumner […]

  10. Gravatar of Brian Donohue Brian Donohue
    20. August 2015 at 09:57


    The 30-year TIPS spread bottomed out at 1.71% on 2/2/2015.

    The spread has closed below 1.9% during 68 trading days this year.
    Prior to 2015, the spread was less than 1.9% on exactly four dates: 8/19/2010, 8/24/2010, 9/30/2011, and 12/30/2014.

  11. Gravatar of E. Harding E. Harding
    20. August 2015 at 11:22

    “Question, what’s the all-time low for the 30-year spread?”
    -December-January 2008-9, at ~.25%.

  12. Gravatar of ssumner ssumner
    20. August 2015 at 11:27

    Thanks Brian, So we are almost there.

    E. Harding. That surprises me. Do you have a link? I’m dubious.

  13. Gravatar of Mark A. Sadowski Mark A. Sadowski
    20. August 2015 at 11:52

    Kevin Erdmann,

    “There is no work, to my knowledge, that establishes a link from QE to the ultimate goals of the Fed””inflation and real economic activity”
    Steve Williamson

    No doubt Steve hasn’t seen the first three parts of my 12 part series where I methodically went through the VAR evidence on precisely that.

    Meanwhile we’re all still waiting (in vain?) for Steve to fit his Neo-Fisherite DSGE model to the data.

    Isn’t it odd how Steve’s bizarre and often contradictory models never get past the theoretical stage?

  14. Gravatar of E. Harding E. Harding
    20. August 2015 at 13:12

    Even though it’s not constant maturity (and is so really more a 20 year than 30 year spread), I’d expect to see the same thing for a 30 year bond issued in 2008.

  15. Gravatar of Kevin Erdmann Kevin Erdmann
    20. August 2015 at 15:16


    Yes, exactly. Even if he has never seen your work, considering the strong scent of conspiracism and cynicism in the air these days, that seems like an irresponsible thing to print on St. Louis Fed. letterhead. Really? He hasn’t seen a single thing?

  16. Gravatar of JG JG
    20. August 2015 at 15:39

    Kevin, at least Hoenig is gone from Kansas City. That guy kept trying to vote to raise rates when everybody else was cutting.

  17. Gravatar of benjamin cole benjamin cole
    20. August 2015 at 15:51

    Evgeny—the promotion of a zero inflation or even deflationary economy seems to transcend ideology, and move into theology.
    What ideological reason is there for monetary suffocation? But proponents of zero inflation say inflation is evil.
    The so-called costs of moderate inflation are scant, while the benefits are obvious.
    Only a generation ago, economists such as Milton Friedman would bash the Fed for being too tight, when the CPI was at 3%!
    Maybe the right-wing has an ideological reason for its attachment to tight money. Perhaps they believe tight money tilts the playing field against labor in favor of capital. See “cutting your nose off to spite your face.”
    But I see no logical reason for the current peevish fixation on zero inflation.
    Btw, the left-wing thinks that raising the minimum wage does not reduce employment—we need some new wings!

  18. Gravatar of benjamin cole benjamin cole
    20. August 2015 at 15:57

    Kocherlokota finally says it: the Fed should do QE.
    Given the shape of the world economy, perhaps QE should be viewed as conventional policy, as apparently it is becoming in Japan.

    I suggest ongoing tax monetization through QE at about $50 billion a month.

  19. Gravatar of dbeach dbeach
    20. August 2015 at 17:17

    Bloomberg has the 30-year breakeven inflation rate based on nominal bonds minus TIPS at 1.76%. I’m not sure precisely where that comes from because the 30-year on-the-run is at 2.75% while the 30-year linker is 1.01%. Maybe the 1.76% is based on market close prices or something.

    Anyway, suffice it to say it is misleading to compute the breakeven rate between the 30-year on-the-run nominal bond and a linker maturing in 2028. (And yes that 13-year linker is paying 0.68%, so there’s the 30 bps difference right there.

  20. Gravatar of dbeach dbeach
    20. August 2015 at 17:22

    Oh, and the all-time low for the 30-year breakeven, according to Bloomberg, is 71 bps, 26-Nov-2008.

  21. Gravatar of All hail Kocherlakota! « Economics Info All hail Kocherlakota! « Economics Info
    20. August 2015 at 18:00

    […] Source […]

  22. Gravatar of Carherine Carherine
    20. August 2015 at 18:04

    Narayana Kocherlakota for president.

  23. Gravatar of E. Harding E. Harding
    20. August 2015 at 19:55

    -Thanks. Even more reliable than my guess based on the linker maturing in 2028.

  24. Gravatar of Lorenzo from Oz Lorenzo from Oz
    20. August 2015 at 20:35

    The power of groupthink is remarkable in central banks. Or perhaps fairly common in bureaucracies, just particularly likely to be dire in central banks.

    (The RBA works rather hard to discourage groupthink by giving its people a wide range of experiences.)

    My impression is that the research publication work of the Fed network is often admirable, but also often not much connected to current monetary policy.

  25. Gravatar of James Alexander James Alexander
    20. August 2015 at 21:43

    I agree about looser monetary policy. But massively more QE without changing the Inflation Target would be like trying to knock down a brick wall with your head. There is no liquidity trap but there is an Inflation Target trap. (A good topic for an academic paper by one of the thousands of pointy heads sitting idly at the central banks?)

    We should use our heads wisely and change the target to combine flexible inflation targeting with more or less known productivity trends and have our Nominal GDP Level Target. It would electrify markets much more than yet more QE and end this Taper Tantrum 2.

  26. Gravatar of dlr dlr
    21. August 2015 at 04:27

    The 30-year TIPS spread bottomed out at 1.71% on 2/2/2015.

    The spread has closed below 1.9% during 68 trading days this year.
    Prior to 2015, the spread was less than 1.9% on exactly four dates: 8/19/2010, 8/24/2010, 9/30/2011, and 12/30/2014.

    We are nowhere near the all-time low. The 30 Year TIPS spread fell below 1.2% in 1998 and below 75bps in 08, though relative TIPS illiquidity is a confounding factor.

  27. Gravatar of Jose Romeu Robazzi Jose Romeu Robazzi
    21. August 2015 at 06:12

    The Fed is worried about “financial frictions”, the risk of bubble formation. They have added a third dimension to their mandate, which makes their jobs increasingly difficult, if not impossible. More than change governance at the Fed, pople should ask congress to narrow their objective once again. This is going to be hard, since he recent trend is exactly the opposite …

  28. Gravatar of ssumner ssumner
    21. August 2015 at 08:44

    E. Harding, I don’t think it would have been the same for a 30 year, but you are right that there would have been a big dip in 2008.

    Lorenzo, I agree.

    Thanks dlr.

  29. Gravatar of Brian Donohue Brian Donohue
    21. August 2015 at 09:23

    @Scott et al,

    My apoloiges. I wasn’t aware that 30-year TIPs were issued prior to 2/22/2010. I don’t have any data prior to that.

    20-year TIPs data goes back to 7/27/2004.

    The 20-year TIPs spread closed at 1.64% yesterday. The last close lower than this was on 5/5/2009 (1.63%).

    The all-time low was a lot lower, though: 0.67% on 11/26/2008.

    So yeah, accommodative monetary policy is probably less urgent than in 2008/2009.

  30. Gravatar of ssumner ssumner
    23. August 2015 at 04:55

    Brian, Yes, I made the same mistake. They stopped issuing 30 years for a while, then started up again.

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