Does the Fed disagree with me? Or are they just incoherent?

I hope everyone knows me well enough by now to guess what I regard as the answer to this question, based on the way I framed it.  I was thinking earlier today about this recent post by Tyler Cowen:

Reading the Keynesian bloggers, one gets the feeling that it is only an inexplicable weakness, cowardice, stupidity, whatever, that stops policies to drive a more robust recovery.  The Keynesians have no good theory of why their advice isn’t being followed, except perhaps that the Democrats are struck with some kind of “Republican stupidity” virus.  (This is also an awkward point for Sumner, who seems to suggest that Bernanke has forgotten his earlier writings on monetary economics.)  The thing is, that same virus seems to be sweeping the world, including a lot of parties on the Left.

Tyler doesn’t come right out and say the Fed disagrees with me, but I think that is the clear implication of his post.   (I’m not afraid to make reasonable inferences about Tyler’s posts, as he’s not inclined to scold me if I am wrong.)  In any case, let’s work with the assumption that most people believe the Fed disagrees with me.  Indeed I think it is widely assumed they think I am a bit of a crackpot, or would think that if they knew of me.  

Before going any further, let’s stop to review what it is I believe:

1.  It would be nice if aggregate demand (or NGDP) where higher.

2.  The Fed can make that happen.

My hunch is that lots of people at the Fed agree with me on the first point.  I recall that last year Janet Yellen said “we should want to do more.”  And then she explained that they couldn’t do any more, because rates are near zero.  And I am quite confident that some of the other doves at the Fed share this view.

I also strongly believe that the right-wingers on the FOMC think that the Fed indeed could do much more.  Right-wingers tend to be contemptuous of Keynesian theories of liquidity traps.  They worry that monetary policy is potentially inflationary.  They think the Fed could do more, but they also think it would be a bad idea.

So most people at the Fed agree with me on at least one point.  Unfortunately those who agree with me on the Fed’s ability to “do more,” don’t think it would be wise, and those who favor more nominal spending, don’t think the Fed could do any more. 

There is nothing new in any of this; I’ve blogged on these ideas before.  But I just want to make sure that readers of Tyler Cowen’s post don’t assume that the Fed is some monolithic institution that has looked at my ideas and discarded them.  All of the views that I listed above are shared by top Fed officials, just not the same officials.  I am very much in the mainstream of American monetary policymakers on every single assumption that leads to my policy recommendation.

You might have noticed that I haven’t yet mentioned the mysterious Ben Bernanke.  If there is anyone who believes both of the views I expressed above, it would be him.  I won’t bore you with his previous statements on Japan, but even in his recent statements you can find evidence of both viewpoints.  When Brad DeLong asked him about a 3% inflation target, he didn’t say “we can’t do that.”  That might have seemed a reasonable response to those who know nothing about Bernanke’s academic reputation.  But trust me, if he had said that he would have instantly become the laughing stock of monetary economists.  He has a reputation for mocking the Japanese claim that there was nothing they could do to boost inflation when rates hit zero.  So I am pretty sure he thinks they can do more.  And Bernanke has also said something to the effect that the Fed sure wished AD would rise—so much so that he recommended some fiscal stimulus in 2008.  So there is plenty of evidence that he is a dove.

You might then be thinking “OK, if he agrees with you Sumner, why did he tell DeLong that he opposes a 3% inflation target?”  There are two possibilities:

1.  Since 2003 he has had a brain transplant, and a new brain was installed by a secret cartel of Treasury bondholders.  He is now the “Manchurian Fed Chairman.”  (Younger readers may not get this reference.)

2.  When Brad asked him that question he might have thought “I wish.  But Brad’s tenacious.  If I say the Fed should do that, he will ask me why we haven’t.  And I’ll have to say that it would promote recovery, but those other bozos I have to deal with on the FOMC won’t let me.  If I throw them under the bus my life will become a living hell.”

You can probably guess which explanation I find more plausible, but I think I’ll wait for his memoirs before going stating an opinion.


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19 Responses to “Does the Fed disagree with me? Or are they just incoherent?”

  1. Gravatar of Will Ambrosini Will Ambrosini
    6. June 2010 at 19:11

    “Younger readers may not get this reference.”

    Well, they remade that movie a couple years ago… 🙂

  2. Gravatar of Jon Jon
    6. June 2010 at 19:42

    Its simple, the Fed disagrees with you. You should go back and reread some of your own remarks about what happens when inflation expectations are lower in the future. Then apply that analysis to what happens under growth-path targeting.

    You’ll see that ‘catching-up’ cannot be a money driven process. It has to be productivity driven.

    For what its worth, I think you’re right that if it were possible to return to the growth-path, everything would be okay.

    I also think you’re right about Fiscal policy. Its subject to expectations. A dollar spent by the government either makes no contribution to GDP (just a transfer payment) or tends to displace private investment. Wasn’t this the Clinton/Rubinonomics? On top of this this is Ricardian equivalence vis-a-vis future taxes to cover present debt.

    We’ve had about two trillion in Fiscal stimulus in the past year–yes, I’m counting the Fed’s MBS in that pool as well as the other off balance-sheet government mortgage arms. The Fed’s actions looks like fiscal stimulus b.c. of the interest on reserves policy.

    Meanwhile… where is the effect? Its no where to be seen.

  3. Gravatar of Morgan Warstler Morgan Warstler
    6. June 2010 at 20:39

    For the life of me, I don’t understand your unwillingness to root for lower prices.

    Productivity naturally drives prices lower, but more to the point – when the price is right a deal gets done 100% of the time.

    And when the tide goes out, the naked guys are supposed to be crushed and their assets sold off for pennies on the dollar.

    Lower prices doesn’t have to mean deflationary spiral of death. And what we’re facing right now is mostly anger that the savers haven’t gotten to buy up the over-leveraged toys of others yet.

    We are zombies until it happens.

  4. Gravatar of Mark F Mark F
    6. June 2010 at 21:17

    Maybe Ben thinks we can do more and ideally should, but will not for political reasons. Right now Bernanke finds himself in an environment where his previously unprecedented monetary base increases have sparked hyperinflation concerns coupled with a continually increase in the questioning of Fed independence. Congressmen and some pundits were even calling for him not to be reappointed. It looks to me like all the political incentives are set up for him to err on undershooting an inflation target. My guess is that the FOMC is in this boat too, in wanting to maintain independence and evade scrutiny.

  5. Gravatar of Mark F Mark F
    6. June 2010 at 21:29

    The obvious response to my argument would be that the Fed could just announce a higher target, so they would still seem in control in the eyes of those predicting hyperinflation. But if you look at the annualized monthly CPI increases, there have already been some pretty big blips, over 10% in June ’09 and around 5% in March ’10. With a bigger inflation target there would be bigger blips, which might spook the ppl that could bring political power down on the Fed.

  6. Gravatar of Nick Rowe Nick Rowe
    7. June 2010 at 04:18

    Yep. It shows that “representative agent models” can be misleading.

  7. Gravatar of scott sumner scott sumner
    7. June 2010 at 06:31

    Will, Older readers (like me) may not realize they remade the movie. 🙂

    Jon You said;

    “I also think you’re right about Fiscal policy. Its subject to expectations. A dollar spent by the government either makes no contribution to GDP (just a transfer payment) or tends to displace private investment. Wasn’t this the Clinton/Rubinonomics? On top of this this is Ricardian equivalence vis-a-vis future taxes to cover present debt.”

    Just to be clear, I think this is only true for any given NGDP target trajectory.

    Morgan, I do root for lower prices, when they come from supply-side factors. I root against lower prices when they come from a lack of AD.

    Mark, The problem with this view is that there are things they could do (like removing interest on reserves) that almost no one would notice. And they aren’t doing them.

    But you might be partly correct.

    Nick, Yeah, I wouldn’t apply representative agent models to policymakers.

  8. Gravatar of David Pearson David Pearson
    7. June 2010 at 07:01

    I think you may have missed the Q&A session from Bernanke’s recent BOJ speech. Unfortunately, the Fed’s web site does not provide transcripts for Q&A. Here is the FT’s transcription. In it, he appears to argue that inflationary tail risk matters once expectations are unanchored. I’m sure this is episode of rationality will pass quickly:

    “In theory, what you would want to do is compare the trade-off between the buffer created by inflation above zero giving you more space to go down in interest rates, versus the costs – the microeconomic and other costs – associated with inflation being too high.”

    “There have been studies that have tried to figure out what the balance is and I don’t know how robust they are, but most of them are very low, they find that the optimal inflation rate is relatively low, and a number have found rates of around 2 per cent to be correct. So it’s a difficult question in the abstract to determine what would be the optimal rate of inflation. But now these studies are assuming that we’re starting from scratch in some sense.”

    “We’re not starting from scratch. The central banks of the world have, over many years now, established a great deal of credibility for inflation rates in the vicinity of about 2 per cent and it would be a very risky transition if we in any way reduce our commitment to a 2 per cent or approximate 2 per cent inflation target.”

    “We’re not sure how expectations would react. It could be that 4 per cent would not be a stable equilibrium and that people would expect an even higher inflation rate after that.”

    “So while I certainly understand the logic of the comment, I think that given the tremendous investment that central banks have made in creating very strong expectations of price stability that we’re better off staying essentially where we are.”

    “And I’d just add as an example of the benefits that despite increases in inflation a few years ago and now declines in inflation towards very low levels, at least in the United States inflation expectations have been remarkably stable, and that is in turn a factor which helps to stabilise inflation itself.”

    http://blogs.ft.com/money-supply/tag/bernanke/

  9. Gravatar of David Pearson David Pearson
    7. June 2010 at 07:10

    BTW, my take is Bernanke (and Kohn) thinks that he saved the world from Depression with “credit easing”, and at no long-term cost of higher inflation expectations. Signs of a double dip would quickly disabuse him of this notion. I think Bernanke has enough of a sense of history to know that the moniker “Great Depression” wasn’t obviously applied until years after the precipitating event. Were the same to be true in his case, we would know in 2011.

  10. Gravatar of Dan Carroll Dan Carroll
    7. June 2010 at 07:25

    That was a remake?

    My take is that it is political pressure on central bank independence combined with a natural institutional risk aversion and fear of change. Indeed, I would think big changes like that would require significant political support, which does not appear to be in place.

  11. Gravatar of jsalvati jsalvati
    7. June 2010 at 07:56

    David Pearson

    That was pretty interesting.

    If central banks think their credibility is so important but so fragile that they are willing to have a big recession to keep it, they should consider switching to a level targeting scheme where credibility is much easier.

  12. Gravatar of Doc Merlin Doc Merlin
    7. June 2010 at 13:34

    @Scott
    “Morgan, I do root for lower prices, when they come from supply-side factors. I root against lower prices when they come from a lack of AD.”

    Lack of AD isn’t always a bad thing. If it is from people trying to dig their way out of excessive debt burden and thus saving more, it can be a very good thing.

  13. Gravatar of What the Fed believes – Economics – What the Fed believes - Economics -
    7. June 2010 at 14:10

    […] that Mr Bernanke is not a dictator. Fed decisions are made by committee. And Scott Sumner has an excellent take on how it might be possible for most members of the committee to believe that unemployment is a […]

  14. Gravatar of Mike Sandifer Mike Sandifer
    7. June 2010 at 14:59

    Scott,

    Have you been following these claims in the news that M3 is falling?

    http://www.telegraph.co.uk/finance/economics/7769126/US-money-supply-plunges-at-1930s-pace-as-Obama-eyes-fresh-stimulus.html

    Here’s also a consultancy’s home page with a chart:

    http://www.imr-ltd.com/default.asp

    You’ve said aggregates aren’t always all they’re cracked up to be, but should this be troubling?

  15. Gravatar of scott sumner scott sumner
    8. June 2010 at 12:56

    David Pearson: You quote Bernanke as:

    “And I’d just add as an example of the benefits that despite increases in inflation a few years ago and now declines in inflation towards very low levels, at least in the United States inflation expectations have been remarkably stable, and that is in turn a factor which helps to stabilise inflation itself.”

    There are so many problems with this I hardly know where to start. Is Bernanke claiming there is no shortfall in AD? If not, why is he talking about inflation being well behaved? Isn’t the whole point if fiscal stimulus to boost inflation and AD? If not, what is the point? If it is, and he thinks inflation is doing just fine, why did he recommend fiscal stimulus? And why does he think inflation is fine, if it is below 1% (core) and trending lower as unemployment is near 10%? Didn’t he just say 2% is the target? Why not try to raise inflation to 2%? And why not use price level targeting to do that? Bernanke seems to be saying the economy does not have an AD shortfall. If that’s what he is saying, I’d like to hear him say it to Congress in very simple easy to understand language, just so we know exactly where the Fed stands. But I doubt he will do that, which still leaves open the question of what he really wants.

    BTW, I do appreciate that quotation. It is very interesting.

    And your second comment is extremely perceptive.

    Dan Carroll, In one way I agree, but don’t you think there might be political support for 3% inflation for two years if it cut unemployment from 10% to 7% and dramatically reduced the budget deficit and risk of higher inflation in the out years?

    jsalvati, Agreed. Doesn’t this really show why we need a clear benchmark like NGDP? With NGDP it would be obvious that the Fed fell short in late 2008.

    Doc Merlin, You said;

    “Lack of AD isn’t always a bad thing. If it is from people trying to dig their way out of excessive debt burden and thus saving more, it can be a very good thing.”

    I think this is a widely held view, but I don’t agree. You can reduce debt and boost AD at the same time if you cut the budget deficit and have an easier monetary policy. I explain this at a recent post in the Economist’s blogging site which they just set up.

    Mike, I did a post 2 or 3 weeks ago on this very article. It’s called “Now that the money supply is falling fast.” Try googling it with the term ‘themoneyillusion’. It usually works.

  16. Gravatar of Mike Sandifer Mike Sandifer
    8. June 2010 at 16:20

    Scott,

    I’m sorry. I read that post and didn’t remember M3 being mentioned. I only remembered the 5 year TIPS spread chart.

  17. Gravatar of ssumner ssumner
    9. June 2010 at 04:37

    Mike, No problem.

  18. Gravatar of Doc Merlin Doc Merlin
    11. June 2010 at 02:45

    ‘I think this is a widely held view, but I don’t agree. You can reduce debt and boost AD at the same time if you cut the budget deficit and have an easier monetary policy. I explain this at a recent post in the Economist’s blogging site which they just set up.’

    Why is it good to cut the federal budget deficit, but individuals doing the same thing is seen as “not enough AD?” I am confused at this point; could you explain why you believe this?

  19. Gravatar of ssumner ssumner
    11. June 2010 at 05:10

    Doc Merlin, I have no objections to individuals reducing debt as well. That’s up to them. AD can go up at the same time as debt goes down. They are two different concepts.

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