Marcus Nunes was right

More than three years ago Marcus Nunes did a post taking on two of my favorite macroeconomists, Robert Hall and Greg Mankiw.  It hardly seems like a fair fight, as Marcus is merely an amateur market monetarist down in Brazil.  And yet, I’ll show that Marcus was correct in both disputes.  In a January 2012 post, Marcus quotes from a Ryan Avent post.  Here’s Ryan:

This time around, Mr Hall addressed the point head on. He noted that in a liquidity trap, the real rate of interest was simply equal to the negative inflation rate. In other words, if the Fed’s nominal rate is at 0% and the inflation rate is 2%, then the real rate of interest is -2%. If a -3% real interest rate is necessary to clear the economy, then all that’s needed is a higher rate of inflation””3% rather than 2%. Mr Hall noted that this was an important point because potentially the Fed could have an enormously helpful impact on the economy simply by raising inflation just a little. And here’s where things got topsy-turvy. Mr Hall argued that (my bold):

  1. A little more inflation would have a hugely beneficial impact on labour markets,
  2. And a reasonable central bank would therefore generate more inflation,
  3. And the Federal Reserve as currently constituted is, in his estimation, very reasonable; therefore
  4. The Federal Reserve must not be able to influence the inflation rate.

Both Ryan Avent and Marcus Nunes thought Hall was wrong.  So did I.  I could have given dozens of reasons.  Bernanke said the Fed could do more.  The Fed had not done the things Bernanke recommended the Japanese do.  The market response to QE rumors. The difference between central banks that did QE and those that didn’t.  Since this time we have lots more evidence, such as the Abe policy in Japan, which has pushed the yen from 80 to 125/dollar.  Despite the recent dip due to falling oil prices, Japanese inflation since 2013 is significantly higher than before.

But even if that was all wrong, we can still be 100% certain that Hall was completely incorrect.  Indeed it’s not even a debatable point anymore.  Why?  I hope it’s obvious to everyone by now.  Hall is wrong because the Fed plans to raise interest rates later this year, even though they expect inflation to continue running below 2%.  So the Fed does not want to raise its inflation target to 3%.  Period. End of debate.

[Isn’t it wonderful when economic debates get resolved with 100% certainty!  It happens so rarely.]

Now on to the next victim, Greg Mankiw.  Here he quotes Mankiw discussing the condition of the economy in early 2012, in light on Mankiw’s own version of the Taylor Rule:

Not surprisingly, the rule recommended a deeply negative federal funds rate during the recent severe recession.  Of course, that is impossible, which is why the Fed took various extraordinary steps to get the economy going.  But note that the rule is now moving back toward zero.  As Eddy points out, “At the current inflation rate, the unemployment rate needs to drop to 8.3% from the current 8.5% for the model to signal positive rates. We’re getting close.”

To be fair to Mankiw, he doesn’t explicitly say the Fed should raise rates when unemployment falls to the low 8% range, even if inflation stayed about the same. There’s some wiggle room.  So let me just say that I think the vast majority of readers would have assumed that Mankiw was stating that policy implication with approval.

In any case, we now know that tightening monetary policy in early 2012 would have been a big mistake.  Actual unemployment has fallen rapidly to 5.4%, and inflation remains well below the 2% target.  Furthermore, inflation is expected to remain below target for an extended period, while unemployment is expected to keep falling. Tightening policy in 2012 would have been a mistake, even if you were a hawkish Fed policymaker who would prefer to ignore unemployment and focus like a laser on their 2% inflation target.

In contrast, the ECB did raise rates a few months before the Nunes post, and we now know that the result was disastrous.

The bottom line here is that the Taylor Rule (in any form) is not a reliable instrument rule.  That’s not to say that the Taylor Principle is without value—I think it contributed to the successful Fed policy of the Great Moderation period.  But as a rigid instrument rule it simple doesn’t work.

PS.  In my tradition of “burying the lede”, let me point to a comment left by Julius Probst:

Yesterday, Larry Summers held a speech at DIW Berlin here in Germany, talking about secular stagnation.
He mentioned that bond markets expect low trend real growth rate in the years to come, low inflation rates and low interest rates – all of that is true in my opinion and I think that the FED is much too optimistic expecting long-term interest rates at 4% in a few years. It won’t happen.

I got to ask Larry Summers a question whether he favors more aggressive monetary stimulus – he does – and whether he favors a different monetary target.

He was against a 4% inflation target, but he favored a NDGP target !!!! I think that might have been the first time he did so in public ? At least the first time I know about it.

The same with me, I’d never heard that he favored NGDP targeting.  Maybe I backed the wrong horse in the Fed race last year.  Oh well.  I’d appreciate it if someone could send a link as soon as possible.  With endorsements by Woodford, Romer, McCallum, Frankel, DeLong, Krugman (sort of), Bullard, and now Summers, there is obviously strong momentum toward NGDP targeting among the macro elite.  So much for the silly view that MM ideas are becoming less popular.  (Of course I’m not claiming that our blog posts actually caused any of these conversions, just that our policy ideas are getting more popular.)


Tags:

 
 
 

30 Responses to “Marcus Nunes was right”

  1. Gravatar of dlr dlr
    1. June 2015 at 06:43

    Doesn’t seem like a fair assessment of Hall. The Fed’s current ability to create 3% inflation does not mean The Fed of January 2015 had this ability, due to credibility limitations. In fact, the refusal of today’s Fed to generate higher inflation, a different institution in important ways than the 2012 Fed, actually supports Hall’s argument that the 2012 Fed had no way to convince people that the 2015 Fed would increase inflation according to the 2012’s Fed’s desires. The 2012 Fed cannot credibly promise a price path except insofar as it can influence the behavior of different, future Feds.

  2. Gravatar of ssumner ssumner
    1. June 2015 at 07:36

    dlr, You completely missed the point. It isn’t about what the Fed can do (yes, that is still debatable) it’s about what they want to do. The Fed does not want 3% inflation, even if that would be a way of preventing liquidity traps, as Hall correctly notes it would. Current events don’t prove him wrong on the ability of the 2012 Fed to create inflation, but rather on the desire to create inflation. It’s not really even debatable; they don’t want 3% trend inflation, even though that would be very helpful in the next recession.

    BTW, the Fed today is very similar to the 2012 Fed; Yellen and Fischer are almost Bernanke clones.

  3. Gravatar of Alfred Alfred
    1. June 2015 at 08:31

    ” Hall is wrong because the Fed plans to raise interest rates later this year, even though they expect inflation to continue running below 2%. So the Fed does not want to raise its inflation target to 3%. Period. End of debate.”

    This is not necessarily the case. The Fed could have judged in 2012 that it needed higher inflation due to the high unemployment, but that by 2015 it no longer does as we are at near full employment. This argument seems to completely ignore the context of those actions.

  4. Gravatar of Michael Byrnes Michael Byrnes
    1. June 2015 at 08:31

    It is probably easier to bank NGDP targeting when you aren’t the chair of the Fed. (That said, all of the recent support for NGDP targeting is very encouraging).

    Isn’t conducting monetary policy by a Taylor rule something like driving a car by looking only at the rear view mirror? If you aren’t going too fast there are probably a lot of roads where that would work, but…

  5. Gravatar of dlr dlr
    1. June 2015 at 09:26

    Scott, I think it is you who is missing the point in this case, in search of an inappropriate gotcha. If you in 2018 have a chance to vote Republican but do not, it is silly to argue that this proves me wrong that you did not want to vote Republican today. At best it is very modest evidence. People, their theories and their desires — they change. This is an important part of the credibility problem. But instead you argue that a claim about Fed’s desires in 2012, which is composed of 40% new people and a new Chair, can somehow be proven wrong by the Fed’s desires in 2015, because “Yellen and Fischer are Bernanke clones.” Come on.

    Even if conditions are the same, your argument that Hall has been proven wrong would be weak, but you are making an additional mistake. You are reading something into Hall that absolutely was not there. He did *not* say that the Fed wanted a 3% inflation target forever more as a way to prevent liquidity traps. He merely said they wanted one at the moment to mitigate *this* liquidity trap by lowering the real rate toward the natural rate. It is easy to imagine a rational a Fed who desired a 2% inflation target, unless that inflation target caused a departure of the real rate form the natural rate, at which point it would raise its target until it could be again safely lowered without causing a contraction. The Fed in 2015 could be perfectly consistent with such a 2012 reaction function depending on whether you believe we are near full capacity. If you read Hall’s Jackson Hole paper in 2013, he specifically says he, himself see a higher “chronic” inflation target as second-best, let alone what the “rational” Fed believes.

  6. Gravatar of TallDave TallDave
    1. June 2015 at 11:09

    Are they really? I was reading the opposite.

    Maybe that’s just since the Q1 number, or Rosengren’s (nonvoting) views aren’t representative.

  7. Gravatar of TallDave TallDave
    1. June 2015 at 11:35

    dlr — The Fed’s current ability to create 3% inflation does not mean The Fed of January 2015 had this ability, due to credibility limitations.

    The Fed is a central bank, they could bid on every asset in existence to support higher inflation expectations in 2012 or 2015. Credibility only concerns how much of what they say they will actually do, it has nothing to do with what they can or can’t do.

  8. Gravatar of ssumner ssumner
    1. June 2015 at 11:57

    Alfred and dlr, Consider the following:

    1. A higher inflation target would have a hugely beneficial impact on labour markets,
    2. And a reasonable central bank would therefore adopt a higher inflation target.
    3. And the Federal Reserve as currently constituted is, in his estimation, very reasonable; therefore
    4. The Federal Reserve must not be able to influence the inflation rate.

    For you guys to be right Hall would have to disagree with one of those 4 claims, after agreeing with the four claims in the post above. Hall is a brilliant economist, I find it hard to believe he’d be that disingenuous. Of course given everything that’s happened since 2012 it’s a moot point.

    BTW, when Bernanke was asked if the Fed was trying to generate higher than 2% inflation he said no.

    dlr, You said:

    “It is easy to imagine a rational a Fed who desired a 2% inflation target, unless that inflation target caused a departure of the real rate form the natural rate, at which point it would raise its target until it could be again safely lowered without causing a contraction.”

    Sure, but not if (as Hall claims) the Fed is incapable of raising the inflation rate.

  9. Gravatar of Anthony McNease Anthony McNease
    1. June 2015 at 12:37

    Can’t affect inflation or won’t (rhetorical question)?

    How much of the $4 trillion in QE has gone to Fed reserve deposits? Data from STL Fed looks like about a $1-2 trillion increase in MB 08. The Fed is willingly offering 25bps IOR. Hall would need to argue that the Fed either can’t go negative for IOR, doing so wouldn’t impact reserve deposits, or that an extra $1-2 trillion (if this is the approximate amount) wouldn’t impact inflation.

  10. Gravatar of Britonomist Britonomist
    1. June 2015 at 14:12

    Why did the Fed want weak growth/stagnation and lowflation?

  11. Gravatar of ssumner ssumner
    1. June 2015 at 15:45

    Anthony, Hall has said that the Fed could go negative on IOR, and that this would have an expansionary effect.

    Britonomist. Inflation was running well above 2% during that period. They didn’t want higher inflation. That’s why they stopped QE2. Yes, they were not happy about the slow growth, but they weren’t willing to raise their inflation target to 3% to do anything about it. Now everyone agrees they can boost inflation by refraining from raising the fed funds target, and everyone can see they don’t want to increase inflation.

  12. Gravatar of benjamin cole benjamin cole
    1. June 2015 at 15:45

    If Marcus Nunes is an “amateur,” then preserve us from professionals.

  13. Gravatar of ssumner ssumner
    1. June 2015 at 15:45

    Ben, Agreed.

  14. Gravatar of Britonomist Britonomist
    1. June 2015 at 16:57

    @Scott

    ” but they weren’t willing to raise their inflation target to 3% to do anything about it.”

    Why not?

  15. Gravatar of Ray Lopez Ray Lopez
    1. June 2015 at 17:05

    “More than three years ago Marcus Nunes did a post taking on two of my favorite macroeconomists, Robert Hall and Greg Mankiw” – hero worship by Sumner. Rest of post save last paragraph not read.

    “Of course I’m not claiming that our blog posts actually caused any of these conversions, just that our policy ideas are getting more popular.” – I hope policy makers or nobody but your closest friends are reading this blog, which makes you look unhinged and your uncritical readers look like cult members. Better if you would withdraw from public debate to give a Wizard of Oz gravitas effect. I notice a lot of the great men do that, pace Krugman and others who don’t mind the fray.

  16. Gravatar of Jim Glass Jim Glass
    1. June 2015 at 17:43

    Why did the Fed want weak growth/stagnation and lowflation?

    They wanted both stronger growth and low inflation, but they wanted low inflation more.

    People can have lots of genuine desires, but only one first priority. (I once saw Kathleen Turner asked about the Matty Tyler character she played in ‘Body Heat’, “Did she love the William Hurt character or was she just playing him for the money all they way through?” She said, “Matty really and truly loved him, but she wanted the money first.”)

    As with people so with institutions. This is writ large across the world of politics. Politicians really genuinely want to do the right thing to make the world a better place, at least very often, but always know that first they must be re-elected and help their parties and allies, etc — and to the extent there is a conflict, first things first.

    Over the years I’ve seen a good number of politicians of both sides say this very explicitly about the national debt/entitlement situation. They well know the current course is unsustainable and heading us all to bad things, and genuinely want to change it — but their first job is to get re-elected and retain power, and to take the lead in publicly admitting and trying to deal with the problem gets one politically killed. First priority first, so we continue on course.

    The Fed genuinely has wanted faster growth and still does, I have no doubt. But its first priority is no more than 2% inflation, for institutional/political reasons of its own.

  17. Gravatar of Britonomist Britonomist
    1. June 2015 at 18:24

    ” But its first priority is no more than 2% inflation, for institutional/political reasons of its own.”

    Okay, well looking at the current context then. When inflation is well below 2%, why is it even thinking of raising rates?

  18. Gravatar of TallDave TallDave
    1. June 2015 at 22:32

    Britonomist — That’s probably the most frustrating thing about Fed comments right now, they’re talking about a “return to normal rates” as though nominal rates are a cause rather than an effect.

    It’s like an extension of the fallacy that nominal rates indicate the stance of monetary policy that is now actually driving monetary policy.

  19. Gravatar of Major_Freedom Major_Freedom
    2. June 2015 at 03:17

    You’re reasoning from a spending change.

    That is flawed.

  20. Gravatar of Anthony McNease Anthony McNease
    2. June 2015 at 07:10

    Scott,

    “Anthony, Hall has said that the Fed could go negative on IOR, and that this would have an expansionary effect.”

    Doesn’t that then contradict his “therefore the Fed can’t influence inflation” statement? Did Hall state this after the fact, or was he saying “yes it’s expansionary, but I don’t believe expansionary monetary policy influences inflation”?

  21. Gravatar of Jim Glass Jim Glass
    2. June 2015 at 07:30

    FYI all, FWIW:

    John Cochrane suggests “a way to have completely run-free interest-paying money, not needing any taxpayer guarantee: Let people and companies invest in interest-paying reserves at the Fed.”

    http://johnhcochrane.blogspot.co.uk/2015/06/bank-at-fed.html
    ~~

    Also, implications for future economic growth in Japan?…

    http://www.bbc.com/news/world-asia-16787538

    Japan population to shrink by one-third by 2060

    … The government report says that by 2060, Japan will have 87 million people, down from today’s 128 million.

    The proportion aged 65 or older is expected to double to 40%. At the same time the national workforce – comprising people aged between 15 to 65 – will shrink to about half of the total population…

  22. Gravatar of Britonomist Britonomist
    2. June 2015 at 07:44

    “That’s probably the most frustrating thing about Fed comments right now, they’re talking about a “return to normal rates” as though nominal rates are a cause rather than an effect. ”

    Are you saying the Fed is now neo-Fisherian?

  23. Gravatar of Jeff Jeff
    2. June 2015 at 08:23

    Scott is right that recent experience shows that we need more inflation, not less. However, as a former advocate of zero inflation, I do remember that there are some arguments in favor of zero. One is that the distortions created by our tax system get worse as inflation goes up. We tax nominal rather than real returns, so higher inflation discourages saving, and the home mortgage interest deduction in the presence of high inflation encourages people to take on ever-larger mortgages as a tax shelter. The fact that both mortgages and most bonds are not indexed to inflation and have fixed nominal payments over the life of the loan means that the effective term of a loan is much shorter, as much of the real principal is paid back early because anticipated inflation raises the nominal interest rate.

  24. Gravatar of ssumner ssumner
    2. June 2015 at 08:33

    Britonomist, The Fed has provided lots of answers, none very satisfactory.

    Jim, Great Cochrane post.

  25. Gravatar of Jeff Jeff
    2. June 2015 at 08:42

    @Jim Glass,

    I like the idea. Better yet, imagine this system:

    (i) Everyone has a debit card for their individual reserve account at the Fed.

    (ii) All transactions (optionally) anonymous.

    (iii) No overdrafts of any kind allowed. Everything is cleared in real time.

    (iv) And since we all like ponies, charge no fees for any of this.

    Now what would happen? I think a system like this would quickly become the preferred means of payment for any and everything. And since the Fed’s only assets are government bonds and notes, we effectively have a 100 percent reserves system. No more bank runs, no chance of financial market disruptions affecting the payment system.

    But as nice as this sounds, I think the 100 percent reserves system with private banks earning interest on reserves is preferable. You still get the financial stability and insulation of the payment system from financial market disruptions, but you also get innovation from the banks competing for customers. You’re not going to get much of that if the Fed is the only game in town.

  26. Gravatar of ssumner ssumner
    2. June 2015 at 08:43

    Jeff, Yes, I’ve made the same arguments about capital income and inflation, although of course it’s not inflation that matters it’s NGDP growth.

  27. Gravatar of Britonomist Britonomist
    2. June 2015 at 11:47

    The impression I get is that the Fed must think unemployment is very close to its ‘natural rate’ and therefore inflation is just around the corner.

    From what I’ve seen, people almost never successfully forecast the true natural rate in advance.

  28. Gravatar of MFFA MFFA
    3. June 2015 at 04:33

    Out of topic:
    https://twitter.com/Austan_Goolsbee/status/606066621728354304

    Good: NGDP targeting being discussed by someone from the University of Chicago who probably has lots of connections with policymakers
    Bad: he does not seem to have much clue

  29. Gravatar of Scott Sumner Scott Sumner
    3. June 2015 at 06:09

    Britonomist, I think you have it right.

    MFFA, Thanks, I’ll do a post at Econlog in about 1/2 hour.

  30. Gravatar of TallDave TallDave
    3. June 2015 at 09:01

    Britonomist — Neo-Fisherian? I don’t think they believe raising rates will increase inflation, no. From their comments they want “normal” rates because hey, normal rates are normal, and normal is good! I’d say they are more scared of the “unusual” near-ZLB conditions than of recession or unemployment.

    I wonder, does the Fed ever look askance at that labor participation rate?

Leave a Reply