Does Barney Frank know what’s going on? (Dual mandate: RIP)

Thorfinn pointed out that my recent posts are almost indistinguishable from Krugman’s:

Why should I bother reading your blog anymore when Krugman is now saying the same thing, with better writing

Believe me, I’d love to stop doing this.  I don’t enjoy it and I’m not being paid.  I’d much rather write about taxes, and indeed had originally intended to spend July (a slow month!) discussing tax issues.  But I keep getting sucked back in.

Unfortunately, it’s even worse than Krugman suggests.  No, not the “depression.”  I think of it more as a Great Recession. What’s worse is Fed policy.

Krugman and I both think QE is worth a shot, but neither of us think it will accomplish much unless the Fed gets serious about inflation targeting (Krugman) or price level/NGDP targeting (me.)  But inflation targeting isn’t even being discussed as an option.  The QE option is considered the most radical step currently feasible, and even then only if things get worse.  In fact, things are already much worse than the Fed thinks.

Here’s where Barney Frank comes in.  Before the recession began he liked to remind Bernanke of the Fed’s dual mandate (inflation and jobs.)  Indeed Barney Frank’s strong opposition to inflation targeting is one reason why the Fed never adopted an explicit inflation target.

Now let’s imagine that the Fed found Barney Frank extremely annoying (it doesn’t matter why, assume they didn’t like his know-it-all manner) and decide that they want to get back at him for stopping them from setting up an explicit inflation target.  What is the worst they could do?  Well, they could completely ignore their jobs mandate, and focus single-mindedly on inflation.  They could say; “We don’t give a damn about 9.5% unemployment, we are going to aim for 2% inflation come hell or high water.”  Yeah, I know, that would be really cruel and heartless.  And it would be rather arrogant to ignore their dual mandate at a time of 9.5% unemployment.  After all, Congress is the Fed’s boss.  The Fed is obligated to carry out Congress’s policy goals.  But let’s just pretend.

While the policy I just described would be extremely hawkish, and would be blatantly disregarding the Fed’s mandate, Krugman showed in a recent post that their current policy is actually far worse than that.  Far more contractionary.  Not only are they ignoring their dual mandate (and yes, I know jobs is a stupid mandate, but NGDP would tell the same story) but they’re aiming for less than 2% inflation.  How do I know?  Because they implicitly acknowledged doing so.  Even Bernanke has admitted that long term inflation forecasts from the Fed implicitly reveal the Fed’s target, just as long term unemployment forecasts implicitly reveal their estimate of the natural rate.

The preceding situation would be awful, but the reality is even worse.  The Fed thinks they will get inflation up to around 1.25% by 2012, but Krugman argues that is overly optimistic, as inflation usually falls during periods of economic slack.  And we have lots of slack.  I don’t buy the slack theory of inflation, but the TIPS market that I focus on tells the same story; only about 1% inflation over the next three years, significantly below even the Fed’s forecast.  Now I agree that TIPS are imperfect, but the Fed’s track record recently also leaves much to be desired.  They failed to forecast the greatest recession since the 1930s until well after the markets were screaming that NGDP expectations were plunging.

But even this understates the audacious way that the Fed is abusing their power.  As Bernanke observed in 2003, when you enter a liquidity trap you need to do price level targeting.  Because prices have fallen well below the 2% trend line from September 2008 (for core inflation) they actually need much higher than 2% inflation to catch up to trend.

Let’s back up a bit and assume I am wrong about price level targeting and take the most conservative assumption that the hawks at the Fed could use.  Assume they don’t trust TIPS, only their own forecasts.  And assume they don’t give a damn about jobs, just inflation.  A simple, memory-less, inflation target.  Even by that criterion they are adopting a far more hawkish policy than could be justified under even the most extreme assumptions.  And they are doing it during 9.5% unemployment.  And I haven’t heard a word of complaint out of Barney Frank.  If he has complained, it hasn’t made any news story that I could Google.

Frank thought inflation targeting was a big problem, and forcefully argued against it around 2006-07.   Why is he not holding Congressional hearings on the Fed’s decision to adopt a policy that is much more contractionary that inflation targeting during a period of 9.5% unemployment.  If this doesn’t obviously violate the dual mandate that Congress gave the Fed, then I submit that the dual mandate means nothing.  What is to stop the Fed from cutting NGDP in half, producing 10% annual deflation and 25% unemployment?  They did it once before.  You say the Congressional mandate wouldn’t allow the Fed to do that?  Then precisely explain to me why the Fed is allowed do what they are currently doing.

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30 Responses to “Does Barney Frank know what’s going on? (Dual mandate: RIP)”

  1. Gravatar of Morgan Warstler Morgan Warstler
    19. July 2010 at 05:56

    Barney needs to shut his mouth, while housing prices fall back to earth, lest we blame him for such high rents.

  2. Gravatar of jsalvati jsalvati
    19. July 2010 at 06:32

    I always figured that the Fed did not want an explicit target because they would have more prestige that way. Why wasn’t a “flexible” inflation (higher inflation during recessions) target acceptable?

  3. Gravatar of Morgan Warstler Morgan Warstler
    19. July 2010 at 07:14

    Fed prestige comes from targeting zero, and reminding everyone the proper fiscal policies will support growth.

    Accepting inflation is letting the DC swine win.

  4. Gravatar of JimP JimP
    19. July 2010 at 07:38

    I agree – it is utterly mysterious as to why Bernanke is doing this. It is, as you say, audacious. This must mean it is conscious. He simply must want what we now have. And it is not as if he doesn’t know what he is doing. He knows exactly what he is doing. He wrote the book on this – and promised the Freedman to never do it again – and now he is.

    He clearly must believe that what we have now is better than what we would have if he announced price level targeting or a higher inflation rate target. How could that be?

    He must fear a kind of quick phase change. Lots of horded cash out there – and an announcement that the Fed would tolerate somewhat higher inflation – and suddenly its twenty percent inflation.

    This is the line of the real perma bears – such as Albert Edwards. The gold bugs. That deflation flashes into hyper inflation right in front of our nose – and the Fed cant stop it. Or Jim Grant. Or Jimmy Rodgers. We are doomed. Better just take our medicine. have a depression and get on with it. There is no use in trying to do anything – because whatever we do ends in hyper inflation.

    But the thing is – those folks are perma bears. They have been telling us we are doomed for years and years and years. They WANT this to end badly – and are doing all they can to promote and create the panic that will make this come true. Its not like they are disinterested.

  5. Gravatar of William William
    19. July 2010 at 07:52

    On today’s Econtalk, John Taylor claims that monetary policy is expansionary, and the interest rate paid on reserves now is too low (0.25 %) to make it reasonable to call it contractionary. I was trying to imagine how you would respond. What difference does paying interest on reserves make, if the rate of interest is very low?

  6. Gravatar of Philo Philo
    19. July 2010 at 08:19

    @ JimP

    “[I]t is utterly mysterious as to why Bernanke is doing this. . . . He simply must want what we now have.” As Scott points out, it is an even bigger mystery why Barney Frank–and Obama and the other Democrats–who, after all, are *in power* at the moment–are tolerating it.

    “He [Bernanke] knows exactly what he is doing.” But evidently Frank, Obama, et al. don’t understand the situation; how else to explain their behavior? The Democrats deserve what they’re going to get in the November elections (just as Hoover deserved it in 1932).

  7. Gravatar of Benjamin Cole Benjamin Cole
    19. July 2010 at 08:24

    There is no more important economic commenmtator right now that Scott Sumner.

  8. Gravatar of JimP JimP
    19. July 2010 at 08:27


    All true – but do we deserve Sarah Palin? Cause the Republicans are going to destroy Obama if things are like they are now, or worse, when he runs again. If he does. Maybe Hillary can take the nomination from him. She at least knows how to fight.

  9. Gravatar of Joe Joe
    19. July 2010 at 10:48

    Professor Sumner,

    But, the FF rate has been following the Taylor rule quite close. I was under the impression that Greenspan was implicitly doing inflation targeting. Ergo, the federal funds rate followed the Taylor rule quite closely.


  10. Gravatar of Mike Sandifer Mike Sandifer
    19. July 2010 at 10:52


    I like your writing and blog better than Krugman’s, and not just because you go into more detail and make things easier for lay people like me to understand.

    By the way, if you have time, what do you think of James Galbraith’s view on how money works for currency issuers? It seems fairly compatible with my intuiton, though I first read about this perspective elsewhere, from Mike Norman. Here is a link to a Krugman critique with the link to Galbraith’s deficit commission testimony within:

  11. Gravatar of scott sumner scott sumner
    19. July 2010 at 12:23

    Morgan, Any comments on the content of the post?

    jsalvati, I don’t understand why Frank would oppose a flexible inflation target. Maybe he assumes it would gradually become rigid. But what we have now is even worse, a target that is flexible in the wrong direction. Low inflation in recessions, and high inflation in booms.

    JimP. That’s why level targeting is so important, to anchor long run expectations and prevent a breakout of inflation. But as long as we have a TIPS market that the Fed can watch everyday, I don’t have much fear of double digit inflation. The Fed can raise rates if TIPS spreads rise, and this will prevent a sharp rise in TIPS spreads.

    William, I can’t even imagine how someone could consider money to be easy right now. Inflation is around 1% and unemployment is 9.5%. The IOR is low, but T-bill yields are lower. So right now hoarding reserves is the best option for banks.

    Philo, Good points.

    Thanks Benjamin.

    Joe, I am not a fan of the Taylor Rule, but I can say that there is widespread disagreement about whether it is following the Taylor rule, as there are many versions of the Taylor Rule.

    Thanks Mike. I don’t have time to read the entire Galbraith piece. But my hunch is that Krugman is right. Is there a specific Galbraith quotation that I could react to?

  12. Gravatar of Andy Harless Andy Harless
    19. July 2010 at 12:57

    I believe that, in the Fed’s own view, it is following its dual mandate (or at least the price stability part), according to the following logic:

    1. To pursue its mandates, the Fed needs to be concerned not just about the mean (or median) outcome but about the whole distribution of possible outcomes.

    2. The Fed believes that, given the higher moments of the distribution of possible outcomes, a more aggressive policy — one which results in a mean expectation of hitting its inflation target within a couple of years — would involve an unacceptably high risk of very high inflation.

    (Note BTW that the Fed’s forecasts can plausibly be regarded as medians, rather than means, of the distribution of outcomes. If the distribution is skewed upward — as I would guess to be the case — then the medians are lower than the means, so the even if the Fed has a mean expectation of hitting its targets, it will forecast undershooting.)

    And though I disagree with the Fed’s policy, I can see their point. They’re relying on untested policies. Who knows how strong the effects will be? Maybe buying up the entire national debt would be just enough to get inflation on a good target path. Maybe buying up a third of the national debt would be enough to cause hyperinflation. Who knows?

    I agree with you that NGDP level targets would help a lot, but I think you far overstate the case. People making day-to-day decisions don’t behave rationally enough, and don’t have enough confidence in the Fed’s intentions or ability, to respond in the way they theoretically should. Moreover, they don’t expect others to behave rationally enough or to have enough confidence in the Fed’s intentions or ability. I think NGDP level targeting based on the pre-2008 trend is the best idea I’ve heard so far, but I also doubt that the immediate effect would be anywhere near as dramatic as one might hope, and I expect that the Fed would have to induce a serious recession once they start hitting their targets, in order to get the NGDP growth rate back down.

  13. Gravatar of Adam Adam
    19. July 2010 at 14:19

    This blog is great and Scott’s posts consistently make intuitive and logical sense to me.

    I may have missed this post, but can someone point me to an explanation of the mechanics of how the fed would target price levels? How would this actually be accomplished?

  14. Gravatar of Morgan Warstler Morgan Warstler
    19. July 2010 at 14:38

    nope. I’m only interested in getting you nailed down to the floor on exactly how the Fed targets NGDP, what actually cause economic activity – the real stuff, where businesses want to take risks, hire people, and those plans seem reasonable enough for loans. You seem to think fear of inflation does it, and it takes more inflation and longer than you think.

    You have said buy Treasuries, you now indicate you think not paying interest on reserves will do it… neither makes any sense to me.

    What does make sense is a massive liquidation of foreclosed housing – that I see lots of economic activity coming from that.

    But you poo-poo that.

  15. Gravatar of scott sumner scott sumner
    20. July 2010 at 07:42

    Andy, I think your description of the Fed’s thinking is plausible, but I don’t view their perspective as being as defensible as you do.

    1. This shows why we need to think in terms of targeting the forecast. If the Fed targets TIPS spreads then there is no danger of a breakout in inflationary expectations. The Fed is not worried about transitory movements in the headline inflation rate that don’t affect wages, they are concerned about changes in inflation expectations. As long as they target the TIPS spread (which they can watch in real time) we won’t have that problem.

    2. If the Fed thinks policy has been expansionary over the past year they are even more misguided than I assumed. The whole point of the interest on reserves program was to sterilize the increase in the monetary base. Even the Fed basically admitted its intent was contractionary. So they certainly don’t have a right to point to the bloated base and say “look at all we have done.”

    Mishkin’s money textbook says low interest rates don’t mean easy money. I certainly hope the Fed doesn’t think low interest rates do mean easy money, otherwise you’d have to argue that Fed policy was easy in the 1930s. So the Fed has no basis for assuming money is already easy, and no basis for assuming the economy is sluggish despite easy money.

    If you are correct about their fear of the risk of a breakout of inflation, then they obviously need to do price level targeting, as Woodford suggests. But they are not doing that, if anything their policy seems closer to inflation targeting, where there is a greater danger of a breakout in inflation expectations.

    Regarding medians and means, I agree that this is a Fed concern. But the TIPS spreads are means, and they signal even lower inflation that the Fed is forecasting.

    3. I think markets are far more rational than the Fed. The markets correctly saw that Fed policy was far too tight in September-October 2008. They saw that NGDP was about to plunge sharply. So I have far more confidence in the markets than the Fed. If the Fed does the right thing, the markets will follow along. Again, the key is to have the Fed create a NGDP futures market, and peg the future NGDP along a 5% growth path. Had they done that investors like me would have prevented monetary policy from going off the tracks in late 2008, as we would have been madly selling NGDP futures–which would automatically boost the monetary base.

    Adam, I don’t think there is any one post, but here are some principles:

    1. I prefer a NGDP target, but if inflation is the target they can use the TIPS markets to derive inflation expectations. Then ease just enough to get inflation expectations in the TIPS market up to the target level.
    2. Actual easing can be done through more supply of money (open market purchases) or less demand for money (lower interest rate on excess reserves, perhaps a negative rate.)

    Morgan, See response to Adam.

  16. Gravatar of TheMoneyIllusion » Extended UI benefits may cause tighter money. TheMoneyIllusion » Extended UI benefits may cause tighter money.
    20. July 2010 at 10:40

    […] It also loosely relates to a point that Andy Harless recently made in the comment section to one of my posts.  Harless argued that the Fed may be reluctant to engage in unconventional easing out of fear […]

  17. Gravatar of MW MW
    20. July 2010 at 11:53


    A hypothesis to explain why the Fed is doing nothing:
    Let’s say potential growth is 3%, (a plausible consensus number, pre-crisis). If the Fed thinks that real GDP growth will be 3.25% in ’10, 3.85% in ’11 and 4% in ’12 (using midpoints from the Minutes), then they believe the output gap is closing and will continue to close. There is no need to ease policy.

  18. Gravatar of Andy Harless Andy Harless
    20. July 2010 at 14:44


    1. If the Fed targets a futures price, it can only target one horizon at a time. (It can try to target more than one by playing with its asset side, but I doubt it would have much success.) But surely the Fed cares (and should care) about a variety of horizons. If it targets a specific maturity of TIPS spread, it risks an inflationary breakout at any longer horizon. (And if it targets a very long maturity, it risks a serious depression at a shorter horizon.) Also, it risks getting whipsawed by changes in risk/liquidity premia associated with TIPS vs. nominal bonds. (I’m guessing this might be an even bigger problem with long-horizon NGDP futures, since my impression is that futures with distant settlement dates usually have low liquidity, and I can’t see a way to do NGDP futures with a settlement date before the actual horizon date.)

    2. The distinction between expansionary and non-expansionary policy (that is, the notion that there is a neutral point rather than just saying some policies are more expansionary than others) is somewhat arbitrary. The question is, what is the distribution of possible outcomes going forward? I think the Fed can point to unconventional policies (initially sterilized but ultimately mostly unsterilized) and say, “We don’t know what the effects of these policies at a 2-3 year horizon will be.” As to their median expectation, why should they not believe the consensus of economists, which is forecasting a continued recovery and a rising inflation rate? And why should they not believe that the variance around that median is much higher than usual, given that many variables are outside the historical range and the policies that induced the recovery were unconventional?

    3. It’s not just financial markets that need to be rational; it’s workers and businesses too. Suppose a set of NGDP targets based on returning to the earlier trend line. By the time we get back to the trend line, big wage increases may have become normal, and, in order to continue following the trend, wage growth will have to be reduced. I’m guessing there will be a recession involved (that is, the initial part of the slowing of NGDP growth will be due in part to a decline in RGDP).

    And what if the monetary base had gone up much faster than it even did in late 2008? It might have been able to stabilize NGDP futures at some horizon, but the variance around the actual outcome would still be very high. I’m guessing that either the shorts or the longs would have ended up losing a lot of money. (Not that there’s anything wrong with speculators losing money. I’m just saying I’m not confident that actual NGDP outcomes — particularly under unusual circumstances — would be all that stable under a targeting regime.)

  19. Gravatar of scott sumner scott sumner
    21. July 2010 at 06:45

    MW, But output should recover at a 6% to 8% rate after a severe recession. That’s generally been true in the past.

    And I think the Fed is being over-optimistic.

    Andy, I don’t quite follow your first argument. I agree that the Fed can hit only one target at a time, but that’s equally true of policy regimes that don’t involve futures targeting. Suppose the Fed’s policy target is X, Y and Z. In that case they’d still need to target a weighted average of X, Y and Z. In that case you can create a futures contract that is a weighted average of X, Y and Z.

    I don’t agree with the inflation overshoot theory because I see that as being based on the false “long and variable lags” view of monetary policy. When I studied the 1930s (where monetary shocks are easier to identify, there were no long and variable lags.

    Once you move to futures targeting, policy affects your target immediately. Unless you assume that markets are not efficient, and that low NGDP futures prices might be associated with high NGDP growth expectations, then there is little risk of a significant overshoot. Under futures targeting, money responds endogenously according to the demand for money at various expected NGDP (or inflation) rates.

    Here is a simple example. Suppose the Fed targets one year forward NGDP along a 5% growth track, and announces it will continue to do so in the future. Then NGDP growth expectations will be well anchored many years out into the future. If they were not, it would offer easy profit opportunities to anyone who saw high inflation around the corner. But we know that it isn’t easy to get rich by trading futures, so we should be suspicious of any scenario that implies it would be easy to get rich.

    Regarding liquidity and risk issues, I argued that in late 2008 the rush for liquidity may have exaggerated the TIPS spread. But that doesn’t mean it was sending the wrong signal, as that widening spread suggested that much easier money was needed for other reasons. The real interest rate on TIPS soared in the July to November 2008 period. There is nothing “misleading” about the rise in real rates on TIPS, the same thing was happening on most other bonds. Conventional T-bonds (with low yields) were the odd man out during the rush for liquidity. So even if the TIPS were distorted, it was distorted in the sense that money wasn’t as easy as it looked, it was conventional T-bond rates that were distorted. And that also suggested that easier money was needed. But I agree that TIPS spreads aren’t optimal, NGDP futures would be much better. Here is an earlier post that I did on NGDP futures targeting, which addresses some of the objections:

    I’ve also published papers on this idea, as have a number of other individuals. i can’t address all your question

    Regarding your second point: If the Fed really thinks no more monetary stimulus is needed, then why did the Fed call for fiscal stimulus in 2008? In 2008 I had lunch with Mankiw and discussed this very topic. I said, “Doesn’t the Fed know that the economy is likely to fall short of its objectives?” Mankiw said something like “believe me they know it, they just don’t know what do do about it.” I feel like I am always fighting a battle on two fronts. There are some who say the economy doesn’t need stimulus. OK, but then in what sense has there been an economic crisis at all? Now I suppose one could argue, “yes, monetary policy was far too contractionary in 2008, but it is right on target today.” But since I was corrct in pointing to TIPS spreads in October 2008 (and I think almost everyone, including the Fed, would now admit I was right) then I am not likely to suddenly think that the Fed can forecast better than the TIPS in 2010. And the TIPS say money is still too tight, especially given that we should now be doing level targetin, not inflation rate targeting.

    Also, do you think that Bernanke would dare go to Congress and take that stance? Would he say, “No point in arguing whether additional fiscal stimulus will solve the AD problem, because there is no AD problem”? Of course not. Perhaps he does believe that, if so I think he is wrong. But if so, that suggests Congress needs to go back to the drawing board and figure out what they want the Fed to do. I don’t think Congress believes there is no AD problem.

    It’s possible you view all this as beside the point. It reflects my peculiar way of looking at monetary policy (Lars Svensson’s approach), which is expectations driven. In my view there is no such thing as what Krugman calls “depression economics” i.e. macro policy for a depressed economy, but rather there is “expected depression economics” which is a situation where a depressed economy is expected in the future. And I equate an “expected to be depressed economy” with incompetent monetary policy. Money is by definition (too) tight if the economy is expected to be below target in the future. If at the current steering wheel setting the ship is expected to miss the port, you need to adjust the steering setting. I don’t buy the asymmetric errors argument–I see no reason not to steer for the policy goal. If you want 2% inflation, you set policy such that 2% inflation is expected. And that’s ignoring the fact that you should actually want to modestly overshoot, to catch up for the undershooting of the previous 20 months. Why would the Fed be more concerned about overshooting than undershooting, especially at a time where they have continually undershot in the recent past. Is the 4% to 5% inflation we had under Volcker in the 1980s really far worse than 1% deflation, which raises unemployment sharply and dramatically worsens the financial crisis? I’m not saying you are wrong about the Fed’s thinking here. There are definitely some strong hawks at the Fed. I just don’t see any justification for that view.
    So to summarize this rambling answer, there are two possibilities:

    1. Things are expected to be fine
    2. Monetary policy is off course.

    You’ve suggested that the Fed thinks things will be fine in the future. I agree that some of them do think that. But others (Yellen, for instance) say “we should want to do more.” I differ from Yellen in that I think not only should the Fed want to do more, they have the ability to do more.

    Response to 3. Wages are the last thing to move. If you steer the more flexible prices in the right direction, wages won’t suddenly get out of line. They rise after monetary policy has already failed to control inflation, or more accurately NGDP. If workers were afraid that “easy money” was going to generate inflation, you’d already see evidence of that in labor markets. After all, everyone seems to think money is really easy right now. If the TIPS spreads say no inflation is coming, and some Austrian wackos are screaming about hyperinflation, which one will labor markets follow? I can almost guarantee it will be the TIPS markets. Otherwise we’d already see wages shooting up like gold prices.

    Regarding the base in late 2008, this reflected two things:

    1. Interest on reserves
    2. Hoarding in anticipation of deflation

    If you have a 5% NGDP futures regime in effect, with no IOR, you’d have hit you 5% target with a normal level of base money, around $850 billion. I know that sounds counter-intuitive, but the high base actually reflected two aspects of tight money:

    1. IOR
    2. Expectations of falling NGDP

    People tend to think in terms of changes in the money supply (or fed funds rate) as the Fed “doing something” whereas targets are seen as just sort of vague goals. But if the Fed had an explicit NGDP target it would be a policy tool every bit as important as open market operations, and indeed far more powerful. In that case the base becomes endogenous. The question is not “how much money would we have needed to maintain a 5% NGDP expected growth rate.” It is “if NGDP is expected to grow at 5%, how much base money does the public and banks want to hold?” Probably not very much in a normally performing economy, but this is hard to prove other than by noting that large real demand for base money are generally associated with depressed economies.

    I am not used to getting so many tough question back to back, so I am afraid my answers are a bit rambling. But I appreciate the time you are spending in giving me feedback.

  20. Gravatar of Extended UI Benefits May Cause Tighter Money Extended UI Benefits May Cause Tighter Money
    21. July 2010 at 22:33

    […] It also loosely relates to a point that Andy Harless recently made in the comment section to one of my posts.  Harless argued that the Fed may be reluctant to engage in unconventional easing out of fear […]

  21. Gravatar of MW MW
    22. July 2010 at 02:26

    “MW, But output should recover at a 6% to 8% rate after a severe recession. That’s generally been true in the past.

    And I think the Fed is being over-optimistic.”

    Scott, why ‘should’? That sounds like Friedman’s ‘Plucking’ Model. It doesn’t take into account context: other post-war recessions did not follow a ‘twin’ financial and housing crises. Nor were they as synchronised, globally (etc). It seems to me that there is/will be much less ‘pent-up demand’ for housing and durables in this recovery (due to larger stocks of those goods among consumers, and less credit demand and supply), and I believe those are what drove prior recoveries.

  22. Gravatar of scott sumner scott sumner
    23. July 2010 at 05:49

    MW, You might be right, but until we get fast growth in NGDP, we will never know whether this ‘reallocation’ story is the real problem. Your theory suggests that we should be currently having above normal inflation. Other things equal (i.e holding NGDP growth constant) lower RGDP growth means higher inflation. And I just don’t see the inflation.

  23. Gravatar of 123 – TheMoneyDemand Blog 123 - TheMoneyDemand Blog
    24. July 2010 at 02:51


    I’ve just returned from a holiday and I am trying to catch up with the amazing quantity of excellent posts you wrote during last two weeks (BTW Scotland is a much more better country for tourism than I expected).
    In February I predicted that Fed hawks would be in an uncomfortable position by now as Bernanke’s trick of publishing forecasts should start to bite:
    But with Barney Frank doing nothing hawks apparently are still sleeping well.

  24. Gravatar of ssumner ssumner
    24. July 2010 at 16:39

    123, Good to have you back. I like Scotland.

    That’s a nice post, but one question. The “few” discussing asset purchases; couldn’t they be either hawks or doves? It didn’t say whether they wanted to speed them up or slow them down. Or did I miss smething?

  25. Gravatar of 123 – TheMoneyDemand Blog 123 - TheMoneyDemand Blog
    25. July 2010 at 03:56

    the discussion in 2010 January FOMC meeting was about what to do next with almost completed QE asset purchase program. Hawks said the following:
    “Several thought it important to begin a program of asset sales in the near future to ensure that the Federal Reserve’s balance sheet shrinks more quickly and in a more predictable manner than could be achieved solely by redeeming maturing securities and not reinvesting prepayments; they judged that a program of asset sales spread over a number of years would underscore the Committee’s determination to exit from the period of exceptionally accommodative monetary policy in a manner and at a pace that would keep inflation contained without having large effects on asset prices or market interest rates.”

    The consensus was:
    “Most judged that a future program of gradual asset sales could be helpful in shrinking the size of the Federal Reserve’s balance sheet, reducing reserve balances, and shifting the composition of securities holdings back toward Treasury securities; however, many were concerned that such transactions could cause market disruptions and have adverse implications for the economic recovery, particularly if they were to begin before the recovery had become self-sustaining and before the Committee had determined that a tightening of financial conditions was appropriate and had begun to raise short-term interest rates. ”

    Only a small dovish minority was willing to even mention the potential need to increase the size of QE program:
    “A few suggested that the pace of asset sales, and potentially of purchases, could be adjusted over time in response to developments in the economy and the evolution of the economic outlook.”

  26. Gravatar of ssumner ssumner
    25. July 2010 at 18:46

    Thanks 123. And I’m guessing Bernanke was in the middle group.

  27. Gravatar of 123 – TheMoneyDemand Blog 123 - TheMoneyDemand Blog
    26. July 2010 at 02:58

    Any guess about who were QE doves in that meeting?

  28. Gravatar of ssumner ssumner
    26. July 2010 at 10:48

    123, I don’t even keep track of who’s on the FOMC. The Boston president is a dove, so is Yellen. But you probably know more than me.

  29. Gravatar of MW MW
    30. July 2010 at 06:40

    “Your theory suggests that we should be currently having above normal inflation. Other things equal (i.e holding NGDP growth constant) lower RGDP growth means higher inflation. And I just don’t see the inflation.”

    Why ‘above normal inflation’ (taking normal to be ~2.5% yy for headline PCE)? I understand this is because of your ‘constant NGDP growth’ caveat, but why would NGDP growth stay constant? I don’t get the theoretical reason for that and empirical evidence (1980, 1981, 1990, 2000) does not support your argument.

  30. Gravatar of ssumner ssumner
    31. July 2010 at 07:19

    MW, If you claim the recession is caused by real factors, not nominal, then that implies faster NGDP growth would not help real growth.

    I view NGDP growth as the best indicator of monetary policy. If it slows, money is tighter. If RGDP slows while NGDP is growing at the normal rate, then real factors are to blame (a la 1974.)

    I’m not saying there are no real factors in the recession, there are. But I see no reason why the sharp fall in NGDP growth is not the main problem. We know that sharp falls in NGDP growth cause severe recessions even when there are no financial and supply-side problems in the economy (1930, 1921, 1982, etc.)

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