Does the Fed still matter?

I occasionally see articles suggesting that central banks no longer matter.  There are generally written by journalists who focus on financial markets.  Obviously monetary policy is always important, so what can these articles possibly mean?

In my view, what’s going on is that journalists occasionally notice that the markets have become indifferent to monetary policy decisions.  That’s likely to occur when it doesn’t make much difference whether the Fed changes its interest rate target (or QE target), or not.

A few years ago, markets reacted very strongly to rumors of a possible Fed rate increase.  That’s because NGDP was at a suboptimal level, and the Fed policy stance had been too contractionary for a number of years.  A rate increase would make the economy noticeably worse off than if the Fed refrained from increasing its fed funds target.  (Recall that the Fed uses the fed funds rate as a signal of easing and tightening of policy.)

In recent months the level of NGDP is close to the level that results in macroeconomic equilibrium (employment close to the natural rate and inflation expectations close to 2%.  Thus the market is relatively indifferent as to whether the Fed raises rates or not.  As a result, Fed related news doesn’t have much impact on asset prices.  But this doesn’t mean the Fed no longer matters, just that they are no longer the destabilizing force that they were during the 2008-15 period.

And that’s good news!

But don’t worry, they are bound to mess up again and some point, and then I’ll switch over from Trump bashing to Fed bashing.

PS.  I did a recent post on how the ECB may raise rates next year.  This article suggests that the BOJ may also pull back on its QE program, as inflation is rising in Japan.  (I think that would be a mistake, but the point is that it’s never been about being “out of ammo”, it’s always been a lack of desire to create faster NGDP growth.)



12 Responses to “Does the Fed still matter?”

  1. Gravatar of Benjamin Cole Benjamin Cole
    10. March 2017 at 17:12

    Still plenty of slack in the global economy, and the Fed is the globe`s central banker.

    The world is glutted with capacity and glutted with capital.

    Inflation a paper tiger.

    This is no time for little boys in short pants in central banking.

    We need men who will pursue Full Tilt Boogie Boom Times in Fat City.

    PS get rid of property zoning.

  2. Gravatar of Postkey Postkey
    11. March 2017 at 01:25

    “Global Slack, US Inflation and the Fed’s Policy Error
    The Fed, along with most other central banks and international macroeconomics institutions (IMF, OECD, World Bank), relies on the standard Phillips curve theory that relates the rate of change of inflation to national measures of slack such as the output gap or the unemployment rate. In particular, labor market tightness is expected to generate wage pressures, which in turn would cause inflation to accelerate.
    The problem is that the standard, domestic, accelerationist Phillips curve no longer captures the inflation process. Figure 1 shows the US output gap vs. change in core PCE inflation over four periods: 1960-1973, 1973-1990, 1990s, 2000-2016. We have used quarterly data from the CBO and FRED. We see that the model worked from 1960 through 1990, weakened in the 1990s, and then disappeared after 2000.
    There are two competing explanations for the demise of the standard, domestic, accelerationist Phillips curve. The first is that because inflation expectations have become firmly anchored at the target (no one doubts the Fed’s willingness or ability to keep inflation in check), the inflation process has mutated so that the relationship that works now is between domestic slack and the level of inflation rather than changes in inflation. There is some evidence to support this hypothesis. See Figure 2. The competing explanation is the Global Slack Hypothesis which says that due to the integration of global markets, what now drives inflation is not domestic slack but rather global slack. Due to competition from global rivals, domestic producers in the tradable sector cannot raise prices when the domestic labor market tightens and wage pressures build. Instead, they either rebalance their global supply chains and off-shore production; or they lose business to their foreign rivals. In either case, domestic inflation is determined as much by global slack as by domestic slack.
    The evidence is mounting that the second explanation is the right one. What is especially compelling is the evidence that global slack is statistically significant in ALL countries for which data is available while domestic slack is significant is NONE since 2000. See Figure 3. The last column corresponds to global slack (“foreign gap”); no stars means the variable is not significant; three means it is significant at the 1 percent level.”

  3. Gravatar of rayward rayward
    11. March 2017 at 06:57

    Tim Taylor links to a very good side-by-side summary of secular stagnation and financial cycle drag explanations for slow growth of productivity and the overall economy written by Claudio Borio. Then there’s this warning by Mark Roe of a housing bubble deja vu: I read Sumner because the Fed is all that stands between civilization as we know it and catastrophe and chaos. When the bubble bursts, as it inevitably will, the media will write that nobody saw it coming, including the Fed, and blame the Fed. How we got there, as the result of secular stagnation or financial cycle drag, or a combination of the two, will have receded to the background as Fed bashing will be the sport of the day.

  4. Gravatar of Scott Freelander Scott Freelander
    11. March 2017 at 08:01


    New U6 number may add a tiny bit of support to the idea that a higher than expected number of the long-term unemployed might trickle into the US workforce over time, meaning there’s somewhat more slack in the economy than many realize. The ebb and flow of such a trickle could, again, occasionally lead some to believe we’re at or near full-employment, as inflation sometimes hits the Fed’s target.

    We don’t need QE or anything drastic like that, but I think some unexpected delays in Fed Funds rate increases would get us to full employment more quickly.

  5. Gravatar of Ray Lopez Ray Lopez
    11. March 2017 at 08:06

    Shorter Sumner: Money is largely short term neutral, except on occasion (those times and dates only I, Scott Sumner, can tell you when). Not a bad start Scott.

  6. Gravatar of BC BC
    11. March 2017 at 15:28

    Government officials, including Fed officials, are like umpires in baseball. If they are doing a good job, then you shouldn’t notice them. When you notice them, then often it’s because they are not doing a good job.

  7. Gravatar of Jerry Brown Jerry Brown
    11. March 2017 at 18:04

    Reacting to the title of your post- of course the Fed is going to matter. It is the institution that the government has decided to allow to create actual US Dollars without corresponding liabilities. And to administer the payments system by whatever means necessary to make sure that system always functions. Even if all other monetary policy was ineffective, these functions matter.

  8. Gravatar of TallDave TallDave
    11. March 2017 at 20:38

    When my toddler asked me where the water in the water tower comes from, I had to look it up (turns out they pump it here from a town bordering Lake Michigan). No one else cares. The water just always works. My wife, though, just the other was telling me how the place she grew up in gradually lost pressure until they had to carry it up to the third floor. They all had to learn a lot about where their water comes from (and even then it didn’t help).

    I know nothing about my water company. I wish knew I less about my central bank.

    but I’m more optimistic than you. I think the Lars Christiansen 2015 Fed Tour (still have the t-shirt!) opened some eyes — market monetarism answers too many questions to be ignored once people start considering it.

    Someday the monetary policy will just work and we won’t have to think about it much.

  9. Gravatar of W. Peden W. Peden
    12. March 2017 at 03:47


    Have you seen this chart? It looks like the US is very much the exception rather than the rule when it comes to house prices, despite the ubiquity of “bubble” narratives:

  10. Gravatar of Ray Lopez Ray Lopez
    12. March 2017 at 09:19

    @Postkey – money is neutral. The Philips Curve does not account for money non-neutrality and fails. People who believed in the Philips curve (and in the quantity theory of money) are being fooled by randomness. Analogy: if I wrote a book about how you can predict the stock market using charts of past data, I’d be laughed at by EMH believers (even though the stock market is not completely efficient, statistically, in the same way money is not completely neutral). So why should we not be laughing at monetarists? Using an over 200 year old construct to ‘predict’ real effects on an economy that is clearly nonlinear is ludicrous. Like our host.

  11. Gravatar of art andreassen art andreassen
    12. March 2017 at 15:09


    I never see a discussion about the contribution of fracking to NGDP, employment and inflation during the Great Recession. Why not?

    Fracking has led to an increase in the supply of domestic oil causing a decline in imports from 4 billion barrels per year to 3 billion and a drop in the price of imports from $100 per barrel to $50 dollars . This has lowered our trade deficit and increased our NGDP $200 billion. This increase in NGDP should have contributed to an increase in employment, when a .3 consumption multiplier is included, of 2.6 million.

  12. Gravatar of ssumner ssumner
    13. March 2017 at 05:06

    W. Peden, Yes I use that chart a lot in my PP presentations. But i use a better version, in real terms.

    Art, NGDP or RGDP?

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