Bearish long run Fed forecasts are hawkish policy
The Financial Times attached a bizarre headline to a recent news story:
Jay Powell delivers dovish message to financial markets
Jay Powell could have used this week’s meeting of Federal Reserve policymakers to project confidence that the US economy had turned a corner after the shock of the coronavirus pandemic, with the jobs market showing signs of early recovery and equity prices continuing to rally.
Instead, the Fed chairman and his fellow monetary policymakers reinforced their dire assessment of the country’s economic prospects for the coming years, which will require a heavy dose of support from the US central bank just about as far over the economic horizon as they can see.
In their first economic projections since December, Fed officials estimated that by 2022, the US would still be facing 5.5 per cent unemployment, far higher than pre-coronavirus levels, with core inflation at 1.7 per cent, still below its target of 2 per cent.
Fed economic forecasts are different from private forecasts for the same reason that a ship captain’s forecast of the ship’s path is different from a passenger forecast.
The Fed expects prices to rise by 4.2% between 2019 and 2022, assuming appropriate policy, far below the 6% increase they have targeted. They have provided no explanation as to why this policy stance is appropriate.
Despite the FT headline, this is a very hawkish policy.
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12. June 2020 at 10:57
Yes, it is “hawkish.” Why not make a specific proposal?
You know more than I, but mine would be to start buying long term bonds until the 10 year and 5 year TIPS expected inflation rates were equal to the equivalent of PCE 2% p.a., probably with an explanation of what it was doing.
12. June 2020 at 11:12
Thomas, I’ve done so many, many times–even quite recently.
12. June 2020 at 11:33
Its the same (or worse) by the RBNZ. They released a forecast in May with inflation below 1% goining into 2023, and even deflation next year. And yet they are very clear that there are no operational limits on what they can do wrt monetary policy. But absolutely no explanation has been given as to why they think their policy response is appropriate given they are predicting failure. Its this massive elephant in the room that even the journalists and commentators seem to be ignoring here.
This seems to be a new development for the RBNZ at least. I reviewed the monetary policy statements (MPS) from the GFC and in the following years. All of those MPS predicted a swift return to target inflation (even though they were wrong in hindsight).
12. June 2020 at 12:19
Would that prediction thru 2022 be OK if they added a prediction for 2023 of 3.8% to make up for it (2% average)? Or is that too long of a timeframe? My sense is that it’s too long. They should be trying to get back to the 2% track within 12 to 18 months. Especially nowadays when they are missing low. In 1985, missing high would have been the greater problem given its proximity to the 1970s.
12. June 2020 at 13:35
Matthew, Yes, this is a continuation of a trend we’ve seen for quite a while—central banks not following their mandates and not offering coherent explanations for not doing so.
Bill, That would actually be a tad better, but in practice it would be almost impossible to do. Inflation is “sticky”. Any policy that raises 2023 inflation expectations up to 3.8% would ipso facto raise 2020-22 inflation expectations.
12. June 2020 at 15:19
There seems to be a cognitive dissonance in almost all central banks that I do not understand.
Powell said a few weeks ago that the Fed was never out of ammunition. But now he’s presenting data that seems to prove just that. The only thing missing is that he says: “2% inflation!? We, as the Federal Reserve, we really have no idea how to achieve that!”
My explanation would have been that Powell is a monetary policy non-expert who doesn’t have a deep understanding of the issue. But his predecessors and colleagues, Draghi, Kuroda, Bernanke, you name them, have behaved in very similar, if not identical, ways.
And all this talk of a symmetrical inflation target (and maybe even “overshooting”) a few months ago was apparently just that: talk.
I’m also a non-expert, but my current (non-expert) explanation would be the following. Unlike Scott, central bankers like Powell (and most others) place a lot of emphasis on the supply of credit. So when Powell said that the Fed is never out of ammunition, he meant the supply of credit to banks and large corporations.
Actual monetary policy, to which Scott attaches so much importance, is not recognized as essential (compared to credit) by Powell and his colleagues, that is not what his ammunition statement refers to, and that is why these people lack far too much ambition when it comes to fulfilling their real task: actually achieving the inflation targets.
12. June 2020 at 15:48
As with the reluctance to pursue level-targeting, I think this is about managing expectations and accountability – or a*se-covering to be precise. Neither Powell nor anyone at the Fed wants their forecasts to look excessively optimistic in 2 years (looking excessively pessimistic is okay). People at the CBO must have felt humiliated for years by their stimulus-based and counterfactual forecasts made during the financial crisis. All of which is to say that the Fed may not actually be that bearish. But perhaps that is no comfort.
And why wouldn’t this be the dominant strategy? No-one apart from some cloistered NK academics (many of whom are politically left-leaning and find it politically and reputationally more appealing to support fiscal stimulus than level-targeting), the handful of relatively low-profile Market Monetarists and that amorphous thing that never speaks in words (“the market”) actually believes that monetary policy can do much more when yields across the range are so low. Even Peter Ireland seems to support yield curve control here on account of its ability to reduce yields: https://www.bondbuyer.com/news/how-yield-curve-control-differs-from-qe-and-why-the-fed-may-be-waiting
I wonder if MMs need to spend more time explaining the concrete steppes and the backward induction elements of policy they rely on than on pushing the academically-reputable but intuitively difficult concept of level targeting? The ‘whatever it takes’ element needs more stepping-through. This is how Nick Rowe put it in 2011:
“Eventually, if the Fed bought up every single asset in the economy, and swapped it for cash, NGDP would rise to the Fed’s target path. Prices would rise without limit as the Fed bought up the last remaining assets because the sellers could name their price. And people would hire the unemployed to build factories which they could float on the stock and bond markets and sell to the Fed at any price they liked. Or sell to the people who had already sold all their assets to the Fed.” https://worthwhile.typepad.com/worthwhile_canadian_initi/2011/10/engdp-level-path-targeting-for-the-people-of-the-concrete-steppes-.html
I think almost everyone agrees that easier monetary policy can boost asset prices. But in many popular economics and finance discussions, that becomes a criticism – “All QE does is boost asset prices, not the real economy”. Where MM struggles is to clearly make the link between higher asset prices and more real activity, especially when yields are already so low. Maybe it would help to use the language of Tobin’s q? Asset prices go up so people create more assets. Either way, I see this as the bit that’s missing at them moment.
12. June 2020 at 17:38
The nuttiest president of the post-war era is Trump (some might argue for LBJ or Nixon).
Some of the best Federal Reserve chairs have been Ben Bernanke, Janet Yellen and Jerome Powell. All smart people.
Yet Trump would have been a better Fed Chair than the aforementioned trio, and pursued a better monetary policy.
But “Fed independence” is sacred. Really?
13. June 2020 at 00:06
“Actual monetary policy, to which Scott attaches so much importance, is not recognized as essential (compared to credit) by Powell and his colleagues, . . . ”
For good reason?
“Economies that manage to focus credit creation on productive and sustainable use – i.e. not for consumption and asset transactions – are likely to achieve superior economic performance (high nominal GDP growth and comparatively low inflation, without asset price cycles and with financial system stability). As the World Bank (1993) indicated, and others have also found (Patrick, 1962; Wade, 1990; Werner, 2000a, b; Werner, 2003), at the heart of the East Asian economic miracle has been a process of guiding credit towards productive use and suppressing unproductive and unsustainable (hence systemically risky) use of credit. . . .
Werner (1992, 1997, 2005, 2011b), using Japanese data, shows that credit for GDP transactions explains nominal GDP well over several decades, while alternative explanatory variables (including interest rates and money supply) are eliminated in a reduction from a general to the parsimonious specific model.” P23.
https://eprints.soton.ac.uk/339271/1/Werner_IRFA_QTC_2012.pdf
And, for Spain?
“We conclude that the empirical evidence supports the predictions made based on our model. Predictions 1 to 4 all lend empirical support to the view that the traditional eurozone approach to the sovereign debt crisis has been unsustainable, and that the key explanatory variable, credit creation for GDP transactions, has remained neglected by the Troika.”
https://www.sciencedirect.com/science/article/pii/S0261560614001132
Nothing to do with potatoes, hot or otherwise?
13. June 2020 at 07:50
I hate ad hominem arguments, but it looks like established, unaccountable institutions just screw up.
Maybe 2008 caught them off-guard. But 2020 it’s undeniable that the central banks do not WANT to fulfill their mandates.
It’s time for an arrogant outsider do blow them away. Like all those disruptors in air travel, genetics, and now space travel
13. June 2020 at 08:33
Michael S.
https://www.nytimes.com/1982/09/18/us/reagan-suggests-tighter-control-of-central-bank.html
Reagan proposed placing the Federal Reserve into the Treasury Department, where of course it would indirectly report to the Oval Office.
The disruptor you wanted….
13. June 2020 at 09:37
Rajat, I’m always a bit frustrated when people suggest MMers need to explain how their policies work. It seems to me we’ve done this dozens of times over the past decade. How many more times do we need to keep saying the same things?
The Fed raised rates 9 times in 2015-18. The idea that they struggled to increase inflation during that period doesn’t even pass the laugh test.
Ben, You do know that Trump fired Yellen and replaced her with Powell? Powell was more hawkish than Yellen when he was an ordinary governor. Trump replaced Yellen with someone known to be more hawkish. Your faith in Trump’s ability to conduct monetary policy is bizarre.
13. June 2020 at 13:19
I certainly didn’t mean placing the FED into the Treasury. That’s not disruption, that’s consolidation of the forces that keep getting us into the mess.
I meant free banking much more than wise philosopher king banking. (And there are exactly zero candidates for philosopher kings in the USA or Europe, as far as I can see)
13. June 2020 at 19:32
Scott Sumner:
Revisionist histories are the norm presently, so I cannot criticize you.
But in fact, President Trump did not “fire” Janey Yellen as you say. Her term expired.
Trump has said he had a discussion with Jerome Powell prior to his nomination, and came away with the impression that Powell would pursue a more-expansionary course. Trump is a bit nutty, so who knows what actually transpired in their private conversation.
In any event, Trump has been right (and in agreement with you) that monetary policy should be more expansionary. Bernanke, Yellen and Powell, all pleasant, aware and intelligent people (from what can be gleaned through the media), but all erred on the side of tightness.
Scott Sumner (and others) should ponder what this means. How can it be?
What is it about the Fed that it is institutionally incapable of proper policy, or that Fed leaders somehow become “absorbed by the Fed borg”?
Michael S:
Free banking is an interesting idea, although there is lots of history to suggest private-sector financial actors will leverage up to the point they pose risks to broader systems.
Add on, we have recent examples of the private-sector’s idea of financial insurance, as in AIG. It sold bond insurance to sophisticated institutional bond investors. It collapsed like a house of cards in the first zephyr of the 2008 recession.
For now we have central banks, but they have developed institutional and structural rigidities and biases, same the Department of Defense or USDA or city school systems. The Fed, as a regulatory body, is also subject to industry capture. I mean, really, what is the point of IOER?
Ronald Reagan was onto a good idea, and one that would make for more accountability at the Fed.
If inflation was too high, or the economy too weak, voters could give El Presidente the boot.
As it stands, the Fed can fail chronically, and as long as inflation is low, they get a pass. There is no penalty to the Fed, it staffers or leadership, for even chronic failure.
Never make a government agency independent. And with its own budget? A recipe for inbreeding.
13. June 2020 at 20:08
Scott, I’m sorry to add to your frustrations. As they say, genius is 1% inspiration… 🙂
Seriously, though, I think the 2015-18 rate rise story accords with most economists’ standard (New) Keynesian intuitions. It’s the story of the monetary policy transmission mechanism at the ZLB that still stumps many. Even if people accept that QE did get the real economy out of the Great Recession, we get musings from highly-credentialled economists along the lines that “QE is losing its effectiveness”. We then get the same highly-credentialled experts endorsing YCC instead of asset purchases because they believe that monetary policy works through interest rates rather than through (direct) base and (indirect) velocity effects. While smart people like Bernanke and Yellen speak of YCC as a means of strengthening the Fed’s forward guidance to keep the Fed policy rate low, the craziest thing about YCC is that its adoption is often motivated by the fear of ‘running out of bonds’ to buy. Indeed, the fact that it has (only?) been adopted in Japan and Australia – the former where the BoJ already owns half all JGBs and the latter which doesn’t have that much government debt as a % GDP – is a testament to this. This is ironically the giveaway that the central bank in question does not want to “do whatever it takes” to hit its target. I fear that until the YCC dragon is slayed, we won’t get real reform.
13. June 2020 at 20:46
Sorry this isn’t relevant to current events.
Please correct me if I’m wrong: in the 1980s, the fed raised interest rates enormously, but only modestly reduced the size of the balance sheet.
It seems like selling marginally more fed assets would be less unemployment-inducing than marginally raising rates?
Does this imply that there is some kind of triple mandate? A) promote low interest rates for federal debt B) control inflation C) fight unemployment?
14. June 2020 at 00:58
Boring post. The elephant in the room is that nobody has ever shown, outside of a laboratory setting involving uni students wagering token amounts of money, that money is non-neutral. In the real world, including Zimbabwe, prices adjust instantly and nobody is fooled much by an expansion of the money supply. And that includes 16th century Europe (where real wages per capita fell). And Japan in the 1930s (helped from the exploitation in Manchuria, not from printing money).
14. June 2020 at 04:14
Dr. Ray Lopez:
Japan’s economy grew through the Great Depression, while other developed economies moldered. Japan practiced money-financed fiscal programs, or MMT, through the 1930s, depending on your point of view. It worked.
And you think it was the fantastically expensive colonization of Manchuria that boosted Japan GDP? Wasting money and resources on a war and occupation? Japan also occupied Korea and Taiwan, even earlier.
Such occupations probably benefitted specific industries and companies, who lobbied for such incursions. A US-style foreign policy, with Nippon characteristics. Did such occupations benefit the whole Japanese economy or living standards?
American incomes boomed during WWII. But American living standards would have soared even more had not US citizens been obligated to devote so much output to war. Same in Japan. The MMT worked.
Obviously, too-tight money (the default central-bank stance) can suffocate economies for decades at a stretch. Just look at the Great Depression or the glacial recovery from 2008.
Okay then, what is the “long-run”? Most people are in the employee class, and maybe have 50 earning years. Take away 10 or 20 years and, well, the costs will seem long-term to those people. Like life long. How many lives have you got in the long-run?
14. June 2020 at 04:39
The Fed’s “policy stance” is announcing that the Fed predicts very slow growth, which becomes self-fulfilling. Shifting back and forth from an actual “policy stance”, such as QE, to a virtual “policy stance”, such as a self-fulfilling prediction of a higher or lower growth rate, means Sumner is always right. Does Trump get angry at Powell’s dovish views because, like Sumner, Trump is of the behaviorist school of economic thought and therefore believes Powell’s dovish predictions are self-fulfilling? Next time Trump threatens to fire Powell, someone should ask Trump if he reads this blog.
14. June 2020 at 08:18
Ben, So Trump is incapable of doing the most simple task imaginable (hiring a dove) and yet you believe he could somehow run the Federal Reserve? That’s like saying someone who couldn’t handle a rowboat could captain a clipper ship.
Rajat, But we weren’t at the ZLB during 2015-18.
Otherwise I mostly agree, and until we get level targeting we’ll be spinning our wheels.
Ilverin, Unemployment depends on NGDP. The policy tool used is not very important.
Rayward, You said:
“someone should ask Trump if he reads this blog.”
You do know that Trump doesn’t read, don’t you?
16. June 2020 at 08:03
I read that according to the results of the meeting of the Federal Committee for Open Markets, the Fed kept interest rates at the current level near zero, saying that it “doesn’t even think” about the increase. The central bank gave its cautious forecasts for GDP growth, employment and inflation. But the largest US stock indexes at the close of trading on Wednesday did not show a unified dynamics against the background of news about the Fed’s interest rates at the same level.