Archive for the Category Monetary Policy


NOW you want easier money?

I happened to catch Rick Santelli on CNBC this morning, the first time I had seen him in years.  I recall he always used to complain about the zero interest rate/QE policies of the Bernanke/Yellen years, and indeed mocked the idea that easier money could somehow create growth when bad supply-side policies were holding the economy back.  And yet, now that unemployment is down to 3.7% and inflation is back up to 2%, he suddenly opposes a rate increase. I nearly spit out my coffee.

A number of people have recently asked me about what’s going on with all the conservative commenters suddenly opposing higher interest rates.  Didn’t they warn us a few years back that low rates were causing artificially high asset prices?  If so, wouldn’t we want to unwind these asset bubbles with slightly higher (albeit still extremely low) rates?

Steve Chapman pointed me to a Wall Street Journal piece by Stanley F. Druckenmiller and Kevin Warsh:

The time to be dovish was when the crisis struck and the economy needed extraordinary monetary accommodation. The time to be more hawkish was earlier in this decade, when the economic cycle had a long runway, the global economy ample momentum, and the future considerably more promise than peril.

I do recall lots of conservatives favoring a more hawkish policy in the early 2010s.  During most of this period, unemployment was in the 8% to 10% range and both inflation and inflation expectations were unusually low.  I would have thought that was the time to be more dovish, not more hawkish.  But let’s say I’m wrong and that Bernanke’s monetary stimulus was excessive, perhaps because it triggered high asset prices.  In that case, why would someone who had a hawkish view in the early 2010s now oppose interest rate increases, at a time when asset prices are even higher?

In the forlorn hope that I won’t be misunderstood, let me acknowledge two points:

1. There’s a very respectable argument that the Fed should not raise rates tomorrow.  That’s not what puzzles me.

2.  People have a right to shift their views on the Fed policy stance, indeed that’s appropriate when conditions change.  Thus in the early 2010s I thought Fed policy was clearly too tight, whereas now I think it’s about right, because we are close to their inflation and unemployment rate targets.

Many of my commenters are conservatives who oppose a rate increase tomorrow, but also thought money was too tight in the early 2010s.  That’s fine. What puzzles me is those who thought it was too loose when inflation was 1.5% and unemployment was 8%, but now think that the Fed is likely to make it too tight by pushing rates up to . . . 2.5%—at a time of 2% inflation and 3.7% unemployment.  What’s your model?

The elephant in the room is the head of political party with an elephant mascot—Trump.  He thought rates were too low before he became president, and now complains they are too high.  He thinks his trade war is a reason not to raise rates, even though he also claims that trade wars boost American GDP growth by bringing jobs home, which would actually be a reason to raise interest rates.  Of course, no thinking person takes Trump tweets at face value; it’s all politics.  But that raises an interesting question.  The bizarre flip flop of many conservative commenters regarding monetary policy occurred at roughly the same time as the Trump flip flop, which we all know reflected political considerations.

I don’t wish to impute bad motives to those I disagree with; indeed I’m probably missing something.  I eagerly await a coherent explanation of why a tighter policy was needed when the economy was severely depressed and asset prices were far lower than today, and 2.5% interest rates are excessive at a time when the economy is booming, inflation is back at 2%, and asset prices are far higher than in the early 2010s.

Again, I am not saying these conservatives are wrong today.  There are respectable arguments for not raising rates tomorrow.  I simply don’t understand the conservative model of monetary policy.  You may disagree with me, but when it comes to monetary policy I’m no moron.  I can generally teach even theories with which I disagree, and indeed I often taught the Keynesian model to my students.  But I wouldn’t even know how to explain modern conservative views on monetary policy to my students.  What is the model?

When I go to conservative monetary policy conferences, I hear one speaker after another rail against “discretion”.  But when I read modern conservative commentary on monetary policy, I’m confronted with policy judgments that seem far, far, far more discretionary than anything that came out of new Keynesian economics.  At least the new Keynesians favored targeting inflation at 2% and unemployment at the natural rate.  That’s not ideal, but it’s a sort of guidepost.

In contrast, consider this uber-discretionary set of claims:

In a first-best world, the Fed would have stopped QE in 2010. It might then have mitigated asset-price inflation, a government-debt explosion, a boom in covenant-free corporate debt, and unearned-wealth inequality. It might also have avoided sowing the seeds of future financial distress. Booms and busts take the Fed furthest from its policy objectives of stable prices and maximum sustainable employment.

So a tighter money policy in 2010 would have moved us closer to the “policy objectives of stable prices and maximum sustainable employment” because it would somehow prevent “booms and busts”?  Exactly how does that work?  I haven’t seen such fancy footwork since James Harden went up against the Utah Jazz.

And what happened to conservative support for the Taylor Rule?


“Yes, we can” in a deterministic universe

If you make policy suggestions to Europeans, they’ll tell you that they can’t do that.

Consider the problems that the ECB is having raising the core inflation rate closer to 2%.

Why not do unlimited QE? — “We can’t do that”
Why not raise the inflation target? — “We can’t do that”
Why not level targeting? — “We can’t do that”

They can’t do anything that would actually work.

Consider the problem of sluggish growth.

How about injecting dynamism into France and Italy through supply-side reforms? — “We can’t do that.”

Consider the Brexit fiasco.

How about a better Brexit, say the Norway option? — “We can’t do that.”
How about another Brexit referendum? — “We can’t do that.”

There a sense in which the naysayers are right. In politics, the law of large numbers is very powerful. Things happen for a reason. Options are not chosen because there currently is not enough support for those options.

So what is to be done? One solution is to look for alternative solutions that are politically feasible. But those do not exist. For the moment, there is no hope for Europe. There is virtually no chance that Europe will snap out of its malaise in the next three days.  They won’t do any of the things that might work.

As we look further out into the future, however, things gradually become more hopeful. The longer the malaise continues, the greater the appetite for changes that currently are not politically feasible.

The solution is not to look for alternatives to sound economic policies; there are no alternatives. Fiscal stimulus will not get Europe to 2% inflation. Rather, the solution is to keep beating our heads against the wall, day after day and year after year, until the time is right for effective solutions to be adopted. NGDP targeting plus free market reforms. That’s what I’ll keep promoting. The zeitgeist determines the policy mix; there’s nothing I can do about that. The universe is deterministic. But I can affect the zeitgeist, at least a tiny bit.

You can too.

Is the Fed holding down growth? (Just the opposite)

I occasionally get comments suggesting that the Fed is somehow “holding down growth” in the economy.  That makes me wonder if the Fed has some sort of magic dust, capable of holding down growth without leaving a trace.  So let’s look at some of the traces the Fed has actually left.

Before doing so, recall that some conservative economists claim that the Fed has no first order impact on growth, because money is neutral.  I don’t agree, and neither do those who claim the Fed is holding down growth.

More likely, wages and prices are sticky in the short run.  The Fed can temporarily boost growth by increasing the rate of inflation, and thereby reducing the unemployment rate.  I’ve argued that we should look at NGDP growth rather than inflation, which can be distorted by supply shocks.

So let’s look at the data:

1.  Over the past two years the unemployment rate has fallen all the way to 3.7%, one of the lowest rates in modern history.  Other employment indicators have also been quite strong, with employment rising far faster than the working age population.

2.  Over the last two years, inflation has risen up to around 2%, roughly the Fed’s target.

3.  Most importantly in my view, the rate of NGDP growth has been increasing rapidly, from well below trend to above trend:

Screen Shot 2018-12-07 at 1.22.55 PMOne can’t just argue that the Fed is holding down growth, without providing any evidence.  All the evidence points in the other direction, that the Fed has been juicing the economy.  Perhaps that will change in the future, time will tell.  But they have certainly not been holding down growth in the recent past, precisely because they haven’t been taking the steps that would be necessary to hold down growth—slowing NGDP and inflation in order to raise the unemployment rate.

Some will inevitably argue that there has been a supply-side “miracle” that’s hard to see because the Fed refuses to “let the economy rip”.  Supply-side miracles leave very specific tracks in the data, such as a slowdown in inflation.  But inflation has been rising.  And of course that doesn’t explain the strong NGDP data.

I encourage people not to go with their gut instincts, rather to look very closely at the actual data and think about what it means.  You can’t just make up any old story and be expected to be taken seriously.

Everything in this post is past tense.  Obviously the Fed may start holding down growth in the future, and if so we’d see the unemployment rate rise to a level above the natural rate.  I can’t rule out that possibility, indeed I’d expect it to occur at some point in the next decade.  But as of now it’s clear that they have not been holding down growth, and indeed have been stimulating the economy.  In fairness, that stimulus was appropriate, as for years we’ve been running well below the Fed’s 2% inflation target.

PS.  At the risk of saying “I told you so”, I’d like to remind readers of a half dozen posts I did around 2016-17, where I said I was not convinced that the Fed was trying to keep inflation below 2%, and that it might have been a mistake on their part.  I pointed out that the consensus of private sector forecasters had also erred, not just the Fed.  I said I’d defer judgment for another year to see if they could make further progress on inflation.  And now we are at 2% inflation, just as the consensus of private sector forecasters and the Fed predicted.  I’m willing to stop deferring judgment and come to a conclusion.  I conclude the Fed really does want 2% inflation, which is the average inflation rate since 1990 and also the 30-year TIPS spread.

PPS.  After a recent post on neoliberalism, some questioned my definition of the term.  I was mostly responding to how others use the term.  In other words:

1. Most intellectuals describe the current economic system in most developed countries as neoliberal.

2. Lots of populists on the left and the right have been running against that regime.

3.  And yet the regime seems hard to dislodge, in any significant way.

Again, I was responding to the way that others define neoliberalism (usually with a negative connotation).  Among opponents of neoliberalism, there is enormous surprise and disappointment that so little has changed over the past ten years.  I see that disappointment frequently expressed in essays on the topic.  They expected the aftermath of the Great Recession to produce the sort of change we saw during and after the Great Depression.  It didn’t happen.

PPPS.  China bleg:  I’m looking for empirical studies of Chinese theft of American intellectual property.  Any links would be appreciated.



What kind of Fed “put”?

This caught my eye:

The Federal Reserve has to be careful for appearing to flinch from hiking interest rates due to market volatility or investors will soon be banking on a “Powell put,” said Mohamed El-Erian, chief economist at Allianz.

The Fed’s most recent message, delivered by Fed Vice Chairman Richard Clarida, stressed the Fed is data dependent. This seems to be a shift from the earlier communication that there was a clear need to normalize policy, said El-Erian, the former deputy director of the International Monetary Fund and later the CEO of PIMCO. This shift seems to be a reaction to market volatility in October rather than any “great discovery” about the economic outlook, he said. . . .


“In the last week or so, the word data dependency has started coming back. So this is going to be a real test as to whether the Powell Fed is indeed a different Fed or whether at the first sign of market volatility they flinch like the Bernanke Fed and the Yellen Fed.”

Mohamed El-Erian 

“If they signal that they are going to be more dovish, I can tell you we will be talking about the ‘Powell put’ really soon, so they have to be really careful,” he added during an interview on CNBC.

Should there be a Fed put based on stock prices?  No.

Should there be a Fed put based on asset prices?  Yes.

It’s a mistake to put too much weight on stock prices.  While stocks do react to changes in expected growth in aggregate demand, they also react to lots of other stuff, such as corporate profits, growth in overseas economies, deregulation, tax cuts, trade wars, interest rates, etc.  Instead the Fed should put together a market forecast of expected NGDP growth.  Preferably they’d create and subsidize trading in a NGDP futures market, but at a minimum they should try to estimate the market’s forecast of NGDP growth, based on a wide range of indicators, including stock prices.

There’s nothing wrong with the Fed easing policy after a sharp setback in the stock market, but only if it’s associated with a decline in expected NGDP growth.  I’m not seeing evidence for that in the Hypermind prediction market, but that contract runs out in the first quarter of 2019, so one could argue that the slowdown is expected to occur later.  On the other hand, forecasts of slower growth in the future usually lead to slower growth in the near term as well.

FWIW,  I believe that the Fed should and will raise interest rates by less than they currently anticipate–perhaps just one or two more increases.  But my view is “data dependent”, and might change by tomorrow.

Off topic: The GOP now believes that corporate decisions about where to locate new factories should be made by the federal government, not the private sector.

Update:  The Dems appears to have picked up 40 House seats, with California’s 21st flipping to the Dems yesterday after the GOP led by 7 points on election night.  Congrats to David Levey for predicting precisely this result.  I’d like to see a story explaining why the late votes in California are so overwhelmingly Democratic.  On election night, the media missed the Democratic wave, with pundits talking about Dem House gains of about 28 and GOP Senate gains of perhaps 3 or 4.  It’s now 40 and 1, or 2 at most.  We need better election technology.  There’s no excuse for the slow pace of vote counting.

Beckworth interviews Ozimek

David Beckworth recently interviewed Adam Ozimek for his podcast series, and the discussion focused on monetary policy.  Ozimek pointed out that not enough attention was being paid to the lessons to be learned from the past three years of Fed policy.  The Fed began raising rates in December 2015, and even Fed officials now admit that this was too soon.  Or do they?  That’s one of the issues they discussed.

Ozimek points to interviews with some top Fed policymakers who seem to agree that the natural rate of unemployment is considerably lower than what the Fed estimated back in 2015, and also that the stance of monetary policy back then was less accommodative than the Fed had assumed.  Ozimek wants them to draw the obvious implication from that fact—that policy was too contractionary in late 2015.  There’s really no other plausible interpretation of the statements he cites, but Fed officials don’t quite seem to come out and explicitly make that admission.  This relates to my recent Mercatus policy brief, where I call on Congress to insist that the Fed periodically evaluate previous policy decisions, based on incoming data.

I also tended to view Fed policy as being slightly too expansionary contractionary during 2015-16, although mostly based on their undershooting of the 2% inflation target.  Like the Fed, I underestimated the extent of the decline in the natural rate of unemployment (Ozimek and Beckworth were ahead of me on that point.)  So what implications can we draw from this episode?

1. I believe it’s important to put this policy error in perspective.  It was a consequential error, perhaps costing hundreds of thousands of jobs for a couple of years.  That’s hardly trivial.  At the same time, the error was an order of magnitude less damaging and an order of magnitude less inexcusable that the policy errors of 2008-15.  When figuring out what went wrong with monetary policy, we need to focus almost all our attention on the mistakes of 2008-15.  That’s the elephant in the room.

2.  This episode illustrates the danger of basing Fed policy on estimates of the natural rate of unemployment (Un).  The Fed cannot accurately estimate the natural rate in real time, and hence it’s an exceedingly poor guide to policymakers.  The lesson is not “next time do a better job estimating Un”, it’s “stop trying to estimate Un, and start focusing on variables than you can measure, like NGDP.”  Under NGDP level targeting, there is no need to even measure the unemployment rate—it plays no role in monetary policymaking.

Unfortunately, the Fed is forced to rely on natural rate estimates as long as it targets inflation under a dual mandate approach, as the unemployment rate helps it to determine how much “catch-up” they need to do after a policy miss.  One of the advantages of NGDPLT is that the Fed is no longer forced to try to do the impossible—estimate Un.

They also discussed some research Ozimek did on the relationship between population growth and inflation.  I have not read the research, but if I’m not mistaken the study found a positive correlation between growth in working age population and inflation, both cross sectionally and over time.  Ozimek hypothesizes that this may relate to the impact of population growth on real estate prices.

The cross sectional correlation makes sense to me.  Cities that are growing fast tend to have higher real estate prices than cities shrinking in population, such as Detroit.  The time series correlation is less intuitive. Inflation is determined by monetary policy.  It seems unlikely that the optimal monetary policy calls for higher inflation when population growth is more rapid.  So what’s going on?  My best guess is that the correlation somehow relates to the link between population growth and interest rates, or perhaps population growth and the natural rate of unemployment:

1.  Under the gold standard, price levels were positively correlated with nominal interest rates.  That’s because higher nominal interest rates boosted the opportunity cost of holding gold, which led to less demand for gold, which is inflationary under a gold standard.  Because the expected rate of inflation is roughly zero under a gold standard, anything that boosted the real interest rate, such as faster population growth, also boosted the nominal interest rate, and hence inflation.

2.  In Japan, shocks that reduce the real interest rate seem to be deflationary, as they reduce the opportunity cost of holding yen, thus boosting the demand for yen and the value of yen.  Lower population growth might reduce the real interest rate in Japan.  Of course the BOJ should offset this, but they often do not do so.  Interestingly, they seem to have done better since 2013, enough so that the inflation rate in Japan has risen slightly, even as growth in the working age population has fallen sharply.  Over longer periods of time, however, the inflation/population growth correlation in Japan supports Ozimek’s claim.

3.  Baby boomers started entering the labor force in the late 1960s.  By itself, that’s not inflationary at all, even if it boosted real estate prices.  Recall that real estate prices are a relative price, and relative price increases are not inflationary unless they reduce aggregate supply.  But faster population growth does not reduce AS.  So what explains the Great Inflation?  One factor may have been a misinterpretation of the Phillips Curve relationship.  The faster growth in the labor force (especially among the young and women), led to a rise in the natural rate of unemployment during the 1970s.  At the time, the Fed made exactly the opposite mistake as in 2015—they underestimated Un.  This caused monetary policy to be too expansionary, in a futile attempt at holding down the unemployment rate.  Just one more reason not to use monetary policy to target unemployment.

4.  Reverse causation.  If monetary policy is procyclical then inflation will also be procyclical.  In that case, rising inflation will be associated with growing RGDP.  It will also be associated with a rising population, as the boom draws in immigrants from places like Mexico.

Note that all four of these explanations are entirely ad hoc, so I wouldn’t necessarily expect the correlation between population growth and inflation to hold in the future, at least at the national level.  Basically any correlation one finds is evidence of sub-optimal monetary policy, just as the Phillips Curve relationship is evidence of suboptimal monetary policy.