Andrew Levin on Fed policy

Soon after I finished reading Larry Summers’ powerful argument against monetary policy tightening, Marcus Nunes sent me an equally powerful piece by Andrew Levin, who previously was a special adviser to Bernanke and Yellen (2010-12), and recently joined the faculty at Dartmouth.  The intro paragraph lays out four arguments against tightening policy now.

The Federal Reserve is on the verge of triggering the process of monetary policy tightening. In particular, a number of Fed officials have indicated that the Federal Open Market Committee (FOMC) is likely to start raising its federal funds rate target within the next few months””and perhaps as soon as its upcoming meeting next week. Unfortunately, the rationale for that policy judgment rests on faulty analytical assumptions about the labor market, inflation dynamics, the stance of monetary policy, and the balance of risks to the economic outlook. Consequently, initiating monetary tightening at this juncture would be a serious policy error.

These four arguments are then developed in more detail.  For instance, here are some comments on the balance of risks:

Over the past eighteen months, FOMC statements have regularly characterized the balance of risks to the economic outlook as “nearly balanced.” Of course, that assessment has recently come into question due to a bout of financial market volatility in conjunction with shifting prospects for major foreign economies (most notably China). Regardless of how financial markets may evolve in the near term, however, it seems clear that the balance of risks remains far from symmetric. If the U.S. economy were to encounter a severe adverse shock within the next few years (whether economic, financial, or geopolitical in nature), would the FOMC have sufficient capacity to mitigate the negative consequences for economic activity and stem a downward drift of inflation? For example, if safe-haven flows caused a steep drop in Treasury yields along with a sharp widening of risk spreads, would a new round of QE still be feasible or effective? Alternatively, would the Federal Reserve implement measures to push short-term nominal rates below zero, as some other central banks have done recently? In the absence of satisfactory answers to such questions, it is essential for the FOMC to maintain a highly accommodative stance of monetary policy as long as needed to ensure that labor market slack is fully eliminated and that inflation moves back upward to its 2 percent goal. Such a strategy will help strengthen the resilience of the U.S. economy in facing any adverse shocks that may lie ahead.

This may be the strongest argument against a rate increase now.  I can understand both sides of the argument on the labor market—maybe wages will start rising more rapidly.  But I really can’t see any good arguments on the other side of the balance of risks issue.  The risks of waiting until 2016 are very low in terms of overheating and inflation.  And I’ve never accepted the “financial” argument (bubbles, etc.) as having any validity at all.  Everywhere it’s been tried (America 1929, Sweden 2010, etc.) it’s failed. Are there any successes?  Does the Fed even have any Congressional mandate to go after bubbles?  Is there a model they can point to that explains how monetary policy should prevent bubbles? Marcus also sent me a good paper on bubbles by Gadi Barlevy of the Chicago Fed.  This is from the conclusion:

Finally, with regard to policy implications, my discussion highlights various difficulties in using greater-fool theories of bubbles to justify action against potential bubbles. Although these theories can provide some justifications for why policymakers should intervene, these rationales come with many caveats. For example, policymakers may have to know that traders have incorrect beliefs, even though policymakers would not necessarily be any better at forecasting future dividends than members of the private sector. Other justifications for intervention require policymakers to be perfectly attuned to when bubbles arise””a condition that seems implausible in practice. In fact, greater-fool theories of bubbles naturally suggest the opposite, that is, that detecting bubbles is likely to be difficult. Recall that in asymmetric information models, bubbles can arise only because there is the possibility of mutual gains from trade. Thus, there may be plausible reasons for why agents trade assets beyond trying to benefit at the expense of others. Finally, the social welfare implications that emerge most clearly in these models do not seem to capture the main issue policymakers are concerned with in regard to bubbles. For example, those who argue for a more forceful policy response to potential bubbles typically expect this response to come from central banks. This reflects a view that bubbles are fueled by loose credit conditions, as well as the idea that the collapse of a bubble causes the most harm when assets were purchased on leverage and a collapse in their price would trigger a subsequent round of defaults. Yet in most models of the greater-fool theory of bubbles, credit plays only a minor role or is missing altogether.

If the FOMC wants to go chasing after bubbles, that’s their decision.  But don’t think there’s any scientific evidence supporting this quest.  In contrast, there’s lots of scientific evidence that it would cost thousands of jobs, maybe hundreds of thousands.



31 Responses to “Andrew Levin on Fed policy”

  1. Gravatar of Ray Lopez Ray Lopez
    9. September 2015 at 18:00

    This is another wise post by Dr. Sumner that demands more comments. Why no comments here?

    Dr. Sumner thinks L. Summers is a very x3 good blogger. I always found him trite, conventional and boring, a follower not leader. But I will re-read him with a fresh eye. If Dr. Sumner thinks he’s good I must be missing something.

  2. Gravatar of Jose Romeu Robazzi Jose Romeu Robazzi
    9. September 2015 at 18:31

    Prof. Sumner
    Last week the GDP statistics for the US, the second advance, came out, it looks it came pretty strong, health growth, health wage growth, and sizeable NGDP growth. I have not seen a single comment on most of the market monetarists blogs. Why is that? instead, I have seen the continuing talks criticizing the FED and against tightening. Why aren’t you, instead, looking at the numbers and at least conceding that the economy is a bit stronger than before ? I am confused, perhaps I am missing something here …

  3. Gravatar of James Alexander James Alexander
    9. September 2015 at 22:20

    The revisions are getting so large that it’s hard to trust them. The RGDI figure that was seen as somehow less volatile and more reliable has collapsed. The headline figures you seem to beer ferrying to are QoQ annualised, so magnifying all this noise. YoY figures are not so good. The “new” indicator based on the average of RGDI and RGDP was the lowest, YoY for five quarters at 2.5%. The PCE Deflator stayed at the ultra low 0.2% for a second quarter running. YoY NGDP is low and getting lower. Why don’t you look a bit harder yourself. What are your sources?

    Table 8 is the one the market looks at:

    There are lots of figures on wage growth, here’s one the Fed looks at closely:

    Anyway, it’s all about market expectations, not history.

  4. Gravatar of foosion foosion
    10. September 2015 at 04:20

    Fischer recently said “we should not wait until inflation is back to 2 percent to begin tightening” which has been taken as a hawkish statement.

    It would be nice if they at least waited until inflation was headed towards 2% within the not too distant future to begin tightening.

    A frequent argument is that the economy is strong enough to support a rate increase. This seems a very weak argument and presupposes that higher rates are a good thing. The question should be whether inflation is likely to get out of control, or at least move towards the Fed’s target (or NGDP futures are signaling a need), not whether the economy is unlikely to be damaged by a rate hike.

  5. Gravatar of Jose Romeu Robazzi Jose Romeu Robazzi
    10. September 2015 at 04:38

    @James Alexander
    My sources are the same as everyone else, but I did focus on the Q2 to Q1 comparison. Yes, YOY numbers are not so good. But what bothered me is the total absence of comments.

  6. Gravatar of Benjamin Cole Benjamin Cole
    10. September 2015 at 05:06

    Love it all, but…

    “…it is essential for the FOMC to maintain a highly accommodative stance of monetary policy as long as needed to ensure that labor market slack is fully eliminated and that inflation moves back upward to its 2 percent goal.”–Andrew Levin

    1. The Fed is not being “highly accommodative,” or even accommodative. It is being passively tight. I realize this may be semantics, but we have heard the Fed is “hyper-accommodative” for eight years now. And the market projects core PCE under 1% for next five years. In terms of PR, I advise people to choose better words. The Fed has been “passively tight” or “timid and pro slow-growth.”

    2. The “2% Goal.” Levin advises we move back “towards” the 2% goal. If the Fed in fact has a 2% goal, it is an average, that has been undershot for years. How about the Fed shooting for a 2% average, meaning a 3% target for a couple of years? Like Scott Sumner says, The Fed says 2% is its “goal,” not its “ceiling.” How about some credibility here? If the Fed says 2% is a “goal,” should it not be a goal, and not a ceiling?

    3. Bubbles–gadzooks, the idea that “low rates causes bubbles” rests upon the presumption that free markets are inherently highly unstable platforms on stilts, and too-low interest rates can cause the legs to crumple like blades of grass. You know, investors, borrowers, lenders throw common sense or spread-sheets out of the window, mainline heavy dope, and borrow and spend on koo-koo schemes! Institutional investors become dunderheads!

    So, we have a model that assumes irrational behavior as a premise for economic policy-making. Low interest rates make people irrational.

    Please, print more money. Bubbles was a monkey, not a viable economic concept.

  7. Gravatar of bill bill
    10. September 2015 at 06:37

    I found this line by Larry Summers to be excellent:

    In a highly uncertain world, the Fed cannot be both data dependent and predictable with respect to its future actions.

    What I liked about it is that I believe the Fed says it is data dependent but really seems to me to focus on being predictable. Predictable meaning that they want their moves to be small, smooth and telegraphed. I wish they’d redefine predictable to mean that they are following a particular NGDPLT path.

  8. Gravatar of Ray Lopez Ray Lopez
    10. September 2015 at 07:23

    @Jose Romeu Robazzi – Brazil debt cut to junk today. I’m long on Havaianas, short on Embraer… 🙂

  9. Gravatar of Jose Romeu Robazzi Jose Romeu Robazzi
    10. September 2015 at 07:46

    Yes, not a surprise for most of us though, the government is a mess…

  10. Gravatar of Justin D Justin D
    10. September 2015 at 08:35

    If it was up to me, I’d announce the following at the next meeting:

    1) The Fed’s balance sheet will be run down by not replacing securities which mature or prepay.

    2) The Fed will not hike rates unless Core PCE is at least 2.0% over both the last 6 and 12 months. These values are currently 1.7% and 1.2%, respectively.

    3) As a consequence of 2), the Fed will almost certainly not hike rates in 2015.

    In this set, 1) throws a bone to the hawks, but the intended net effect of these 3 items would be to remain neutral or even ease slightly, and remove uncertainly surrounding the Fed Funds rate for the rest of the year.

    I believe it was only last month that full time employment passed the 2007 peak. U-6 unemployment is 10.3%, which compares to 9.5% in June 2004 when the Fed began to hike last cycle. The employment to population ratio for 25-54 year olds is 77.2%, vs. 79.1% during the last hiking cycle, and 77.0% during January 2009. Average hourly earnings are up at a modest 2.2% pace over the past year. Unit labor costs are up just 1.7% over the past year.

    Given this, combined with various other headwinds to the economy at the moment, neutral to slight easing looks to be the most reasonable choice, if NGDP targeting is off the table.

  11. Gravatar of ssumner ssumner
    10. September 2015 at 09:45

    Jose, I’ve done many posts talking about how the economy is recovering. However when I do those posts I tend to focus in the employment numbers, which are a way of estimating where we are relative to the natural rate.

    My criticism of the rate increase is that it doesn’t get us closer to the Fed’s goal of 2% inflation, it puts us further away. If the Fed switches to a 3% NGDP target, then I wouldn’t criticize the rate increase.

    foosion, Good point.

    Bill, I agree.

    Justin, Very good suggestion.

  12. Gravatar of Jose Romeu Robazzi Jose Romeu Robazzi
    10. September 2015 at 10:22

    @Prof. Sumner, thanks, I follow your comments and get that.
    But I have another criticism, and please, this is not intended to be ofensive at all. We know, from analysis, that the 2% target is not really a target. The Fed in fact uses a range, 1% to 2%, in other words, 2% is the ceiling, not the target. We also know they focus on core inflation. Instead of keep saying the Fed does not meet its targets, shouldn’t we actually request that it states its target clearly? Because if they are targeting 1.5%, they are not so far from the goals as it seems. I think it is easier for the Fed to acknowledge its true target (or band) than to actually change its process. But if we manage to get the Fed to comunicate clearly its own true goals, maybe that is already a big step towards better governance.

  13. Gravatar of bill bill
    10. September 2015 at 11:27

    I’d like to see them do that and also cut or eliminate IOR. The Fed has paid 0.00% IOR for over 90% of its existence, so until they eliminate IOR all their talk about “normalizing” is poppycock.

  14. Gravatar of James Alexander James Alexander
    10. September 2015 at 11:27

    Just because bloggers don’t write about it doesn’t mean the market is ignoring it. You’ve noticed the stock market volatility of course, that tells you those 2nd quarter QoQ numbers were not taken as evidence of robust growth.

    But you are right, a regular, reliable Market Monetarist commentary on key data releases would be useful. Watch this space!

  15. Gravatar of Jose Romeu Robazzi Jose Romeu Robazzi
    10. September 2015 at 11:36

    @James Alexander
    Yes, of course. I do read this and other blogs. The point is that this particular GDP data release was considered by many as supporting the rate hike that looms in the near horizon. I just thougth there was a blank space there.

  16. Gravatar of bill bill
    10. September 2015 at 11:37

    Paul Krugman has a post today (Dynamic Voodoo) with a fantastic graph showing the futility of fiscal policy. Sadly, PK forgets to mention that point.

  17. Gravatar of E. Harding E. Harding
    10. September 2015 at 12:16

    Jose, YOY, it’s still a deceleration.

  18. Gravatar of ssumner ssumner
    10. September 2015 at 12:21

    Jose, Actually we don’t know that. From 1990 to 2010 the Fed treated it as a target, and were equally willing to miss high or low. Perhaps under Yellen it’s become a ceiling, but we won’t know that for some time. (Not saying you are wrong, just that it’s too soon to say, given it clearly was not a ceiling during 1990-2010.

    I strongly agree that they need to tell us their target, whatever it is.

    I will say that the case for hiking rates with 3.7% RGDP growth in Q2 is stronger than if it had been say 1.7%. Perhaps I should have acknowledged that. I just didn’t think the case is strong enough.

    Bill, I beat you to it (at Econlog)

  19. Gravatar of E. Harding E. Harding
    10. September 2015 at 12:26

    Krugman’s chart is deceptive, as the 2001 recession was much milder, than that of 2009, so, obviously, the employment growth would be stronger after 2009 than after 2003.

  20. Gravatar of Beefcake the Mighty Beefcake the Mighty
    10. September 2015 at 12:55

  21. Gravatar of James Alexander James Alexander
    10. September 2015 at 14:26

    3.7% RGDP growth but RGDP became less favoured as it was often volatile (especially on the low side recently). So the VSPs urged people look at less volatile (and higher recently) RGDI. A quarter later and RGDI goes VERY low and volatile. Funny that.

    “GDI is seen by some researchers, including a few at the Fed, as a better gauge of the strength of the economy. While income and GDP should theoretically match, the different methods used in calculating the numbers cause them to diverge occasionally.”

  22. Gravatar of David de los Ángeles Buendía David de los Ángeles Buendía
    10. September 2015 at 15:27

    Dr. Sumner,

    In the 1980’s there were several housing bubbles in different locations. However interest rates were orders of magnitude higher than today. In October of 1981 30 year mortgages had an interest rate of 18.45% and today it is 4.05%[1] yet housing starts in October 1981 was 873,000 and in July of 2015[2] the number of housing starts were 1,203,000.

    So the Federal Reserve Bank and other government regulatory bodies have little ability to prevent housing bubbles, there are no “anti-bubble” policies[3].




  23. Gravatar of Ray Lopez Ray Lopez
    10. September 2015 at 17:03

    @ David de los Ángeles Buendía – your link to housing bubbles in the 1998 Higgens et al paper was good, but anecdotally, you can make money buying at the top of a bubble, if you have the right location. We bought in DC area at the top of the bubble in 1989 (a small bubble) and in 2006 (a big bubble) and both times, due to an excellent location near the DC metro, we made money after a small downturn. It reminds me also of Anthony Downs, a free-marketeer who predicted in 1985 a downturn in real estate due to finance (he was right, but early, see The Revolution in Real Estate Finance – September, 1985 by Anthony Downs), but again, location x 3 trumps all, as D. Trump will tell you (several bankruptcies later). These statistics are for the little people, not for those in the 1% and higher.

  24. Gravatar of Beefcake the Mighty Beefcake the Mighty
    11. September 2015 at 04:16

    Amusing; what happened to the links I posted explaining, in the Fed’s OWN words, why it charges interest on excess reserves? Didn’t fit the narrative?

  25. Gravatar of Scott Sumner Scott Sumner
    11. September 2015 at 06:19

    E. Harding, Just one of many problems.

    James, Good point about GDI.

    David, Yup, not much they can do.

    Beefcake, Comments with links often go into spam, I’ll look for it.

  26. Gravatar of ssumner ssumner
    11. September 2015 at 06:32

    Beefcake, Thanks, I’ll probably do a post on that. The Fed basically confesses to murdering the economy. They did IOR to keep rates from falling.

  27. Gravatar of Beefcake the Mighty Beefcake the Mighty
    11. September 2015 at 09:05

    That’s exactly the point, Scott. The Fed began flooding the system with reserves far in excess of the banks’ demand for them, a full month before IOER was instituted (Sep08 vs Oct08). This would have caused the Fed funds rate to go down to zero, which I’m guessing you’d agree wouldn’t be compatible with macroeconomic stability. Your real problem here is with the law of supply and demand, not Fed mismanagement.

    IOER is a flat-out subsidy to the banks and should be ended for that reason, but it has nothing to do with the MM fairy tale about being an opportunity cost to lending.

  28. Gravatar of Lurker Lurker
    11. September 2015 at 14:42

    @ Beefcake

    “IOER is a flat-out subsidy to the banks and should be ended for that reason,”

    So do you think they should bother with reverse-repo’s or something to try to drain reserves before doing that?

  29. Gravatar of Beefcake the Mighty Beefcake the Mighty
    11. September 2015 at 19:07


    Probably not, no. I don’t see the point in more can-kicking. Take the lumps, get on with life.

  30. Gravatar of ssumner ssumner
    12. September 2015 at 05:24

    Beefcake, You said:

    “This would have caused the Fed funds rate to go down to zero, which I’m guessing you’d agree wouldn’t be compatible with macroeconomic stability.”

    That’s a pretty pathetic guess, unless this is your first time reading my blog. Check out my new post.

  31. Gravatar of Lurker Lurker
    12. September 2015 at 12:06

    @ Beefcake

    “Probably not, no. I don’t see the point in more can-kicking.”

    How would draining the reserves before canceling the IOR be a “can-kicking”?

    Do you see any danger in encouraging banks to start lending against their reserves?

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