Kocherlakota wins 2013 (and Powell loses)

The minutes for 2013 were just released, and I’ve only had time to consider the January transcript. It’s clear that Narayana Kocherlakota is the clear winner.

Most people will focus on the fact that Kocherlakota’s 2013 policy advice (to be more stimulative) was clearly superior, evaluated in retrospect. I pay little attention to that fact, as it might have been merely due to luck. Rather I’d focus on the fact that Kocherlakota laid out a clear and logical approach to monetary policy determination, which was superior to that of the other FOMC members:

Mr. Chairman, my comments are not about the specific changes, but rather about the statement in its entirety. I supported the statement, what I’ll be calling the “principles statement,” a year ago. Today I’d like to reaffirm my support, but even more enthusiastically. By design, the principles statement encompasses a wide number of approaches to the making of monetary policy. Nonetheless, over the past year, I have found it to January 29–30, 2013 be sufficiently specific to provide valuable guidance when thinking about the appropriate stance of policy. To explain my thinking, Mr. Chairman, I think it’s helpful for me to refer back to a speech that you gave in December 2004 called “The Logic of Monetary Policy.” In that speech, you contrasted two approaches to monetary policy. Under what you called the “simple feedback” approach, the central bank responds in a relatively automatic fashion to the evolution of current and past variables. The Taylor rule is one example of this approach. In contrast, under the second, the “forecast-based” approach, the central bank chooses the action that it forecasts will produce the best overall results, taking account of the risks to the economy. Thus, if the central bank judges its results relative to targets for inflation and unemployment, it chooses the policy that is forecast to bring the economy closest to those targets. Lars Svensson has been a particularly vocal proponent of this approach.

As I’ll describe, my reading of what will now be the penultimate paragraph of the principles statement is that it is firmly grounded in the forecast-based approach. Correspondingly, that paragraph has led me to put considerably more weight on the forecast based approach in my own thinking about policy. The opening sentence of that key operational paragraph says that we should begin by asking, will the current path of monetary policy result in deviations between inflation and the longer-run goal of 2 percent? Equally, will it result in deviations between employment and its maximum level? The current policy path does imply such deviations. Then that same first sentence prescribes that we should adopt monetary policy actions to mitigate them. Suppose, for example, that given the current policy path, inflation is expected to run below its longer-run target over the next year or two and employment is expected to run below its maximum level. Then that first sentence implies that we should seek to mitigate those deviations by adding accommodation. Of course, decisions are more difficult when only January 29–30, 2013 one of the two variables is expected to be below its desired level. For example, suppose the current policy path is expected to lead to inflation of exactly 2 percent over the next few years, but also to lead to employment being below its maximum level. Here the second part of the paragraph provides the needed guidance. It espouses a balanced approach in the situation, and this means, I think, that we should add accommodation to mitigate the employment deviation. So I posited that inflation was exactly 2 percent. Adding accommodation would end up resulting in inflation running somewhat above target. But this is, I think, what a balanced approach has to mean: that monetary policymakers are willing to follow policies that give rise to slightly positive inflation deviations in order to mitigate negative employment deviations. The Committee has, of course, explicitly evinced that kind of willingness in the December 2012 FOMC statement.

Key takeaways:

1. Kocherlakota understood that the Fed needed clear policy goals.

2. Kocherlakota understood that policy needed to be set at a position where the Fed forecast equaled the Fed target for those goal variables.

3. Kocherlakota understood that the Fed’s dual mandate implied that if both targets could not be hit at the same time then inflation should be countercyclical, that is, above 2% inflation when unemployment is high, and vice versa.

4. Kocherlakota understood that the 2013 Fed economic forecast under the (consensus) “Alternative B” policy option was expected to lead to below target inflation and employment, and hence that the consensus policy choice was too tight.  This is discussed later in the transcript:

Now, as I said in the previous go-round, given the current stance of policy, I expect inflation to average less than 2 percent over the next two years, and I expect unemployment to remain above 7 percent over the next two years. This forecast conforms closely to the outlook described in alternative B and in the outlook in the Tealbook, and I think it’s actually fairly similar to a wide range of the forecasts we’ve heard around the table, certainly on the inflation front. So we’re confronted with a small negative deviation relative to our inflation goal and a January 29–30, 2013 large negative deviation relative to our employment goal. Yesterday, Mr. Chairman, we took the step of reaffirming the principles statement, the long-run goals and strategy statement, which I think will, over time, assume a quasi-constitutional status in this Committee. I think that statement is clear in its operational, penultimate paragraph about what needs to be done in this situation. The Committee should seek to mitigate these deviations from its goals by adding accommodation.

PS.  There’s discussion in the press of how Bernanke was pressured by the “three amigos” to slow down the QE program.  This led to the famous “taper tantrum” of 2013.  Ironically, two of those “amigos” were Obama appointees to the Board.  Their pressure to curtail QE might have slowed the recovery enough to cost Hillary the election (although of course it’s hard to be sure—in a close election almost anything can swing the result.)  Even more ironically, one of those Governors was appointed by Trump to be Fed chair, despite it being well known that his views were more hawkish than those of Yellen.  Fortunately, he is doing a good job so far, if one judges by the Lars Svensson criterion.



7 Responses to “Kocherlakota wins 2013 (and Powell loses)”

  1. Gravatar of John hall John hall
    11. January 2019 at 15:48

    On the PS, take a look at 5 year TIPs breakevens. They fell below 2% before the December meeting and down sharply before the early January AEA meeting when Powell walked back earlier comments and pledged a more data-dependent policy.

  2. Gravatar of Marcus Nunes Marcus Nunes
    11. January 2019 at 15:57

    Kocherlakota in “real time”:

    And 8 mos earlier:


  3. Gravatar of dtoh dtoh
    11. January 2019 at 16:25

    Key takeaways – Your list is so obvious and elementary. Crediting Kocherlakota for recognizing this stuff is like an award for the youngest horse in the glue factory.

  4. Gravatar of Michael Sandifer Michael Sandifer
    11. January 2019 at 16:34

    Powell certainly hasn’t done a good job by my criteria. His communication has been awful, as has that of people like Williams.

    They’re getting the policy wrong too. Active and passive tightening have been responsible for most of the market volatility over the past few months and the many trillions in losses suffered by those with liquidity constraints.

    Worse to me, though you disagree to at least an extent, they’ve needlessly slowed NGDP and job creation.

  5. Gravatar of Mike S Mike S
    12. January 2019 at 06:43

    What is the consensus on the below statement? Given no changes to the current Fed regime until it is broken?

    In exactly the same way that QE was deflationary in practice when it was inflationary in theory, so will the end of QE be inflationary in practice when it is deflationary in theory. That’s the real world impact I’m talking about, the world of wages and output and productivity. You know, the real world that used to be the touchstone of our markets.

    why haven’t our easy money policies created inflation in the real world? — will soon be replaced by a new head-scratcher — why haven’t our tighter money policies tamed inflation in the real world?

    My view: as the tide of QE goes out, the tide of inflation comes in. And the more that the QE tide recedes, the more inflation comes in.

  6. Gravatar of ssumner ssumner
    12. January 2019 at 09:42

    Mike S, I don’t know the consensus view, but my view is that they have everything backwards.

    Do umbrellas cause rain?

  7. Gravatar of ssumner ssumner
    12. January 2019 at 09:43

    John, Beware of TIPS spreads when oil prices have change dramatically.

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