Beyond hawks and doves

After the recent series of posts on Bernanke I asked readers to send me some information on the FOMC.  I was all set to look for “villains.”  But after looking at the information, I was reminded of something I’ve known all along—the FOMC isn’t the problem, rather the state of macroeconomics circa 2010 is the problem (assuming my critique is correct.)  Given that I am one of only a handful of economists who thought money was too tight in late 2008 and throughout 2009, on what basis would I expect the Fed to follow my preferred policy?

But since I asked for the information, let me give you a few reactions.  They are based on this FT article (supplied by Marcus), which discusses the perceived hawkishness or dovishness of each potential FOMC member, and also this Fed report (supplied by Statsguy) which provides brief biographies if you click on the person’s name.  Some initial reactions:

1.  Many of the Fed presidents and Board of Governor members have banking backgrounds, and seem to be in way over their heads.  Woodford has argued that when in a liquidity trap it is essential to engage in price level targeting, not inflation targeting.  Without disrespect to any single member of the FOMC, how many of those members seem qualified to judge his arguments, merely on the basis of their background?  Just so that this doesn’t sound too arrogant, I would be completely unqualified to serve on a board that oversaw banking regulation.  Having a banking expert serve on the FOMC is essentially no different from having an accountant, economist, or engineer serve on the Supreme Court.  Except the FOMC is much more important.  Do we need banking experts at the Fed?  Sure, if they are going to regulate banks.  But they have no business being on the FOMC.  The FOMC does not determine whether credit is easy or tight, it determines whether monetary policy is easy or tight.

2.  If I sat down and chatted with each individual FOMC member, I would probably have much more in common with the hawks than the doves.  The hawks talk about controlling inflation expectations while the doves discuss “output gaps.”  Like the hawks I want to target only a nominal variable, and ignore the output gap.  Where I differ is that the nominal variable I favor targeting is NGDP, not P, and I want to target levels, not rates of change.  In my view the doves are currently right for the wrong reasons.

3.  The other main problem is that the doves tend to be excessively “Keynesian” in their approach to monetary economics.  Thus Janet Yellen, one of the most dovish Fed presidents, was quoted last year saying that the Fed could not ease monetary policy further once rates hit zero.  At the time I argued that that sort of statement should instantly disqualify someone from serving on the FOMC.  (During late 2008 James Hamilton said something to the effect of “if the Fed doesn’t know how to inflate, let me try my hand at the printing press.”  Can someone find me the exact quotation?)

Many of my natural allies (the doves) failed to push hard for further easing, thinking it futile, while the people who do understand how powerful monetary policy can be at zero rates tended to be hawkish on inflation.  And Mr. Bernanke?  If you read the 1999 paper I keep talking about you will have no trouble understanding why he was my first choice to replace Greenspan.  I’ll look at his memoirs before drawing any final conclusions.

Update 1/10/10:  Statsguy sent me the exact Hamilton quotation:

But if inflation is what you want, put me in charge of the Federal Reserve and believe me, I can give you some inflation.

Notwithstanding, I think Greg [Mankiw] is raising a very valid point. Allowing the overall deflation in the U.S. in the 1930s and Japan in the 1990s was one quite fixable policy error. But perhaps modern macroeconomists have deluded ourselves into thinking that if this policy error had not been made, the whole episodes could have been avoided. How bad would the Great Depression have been if the price level had not fallen? Not as bad as it was, I’m convinced, but maybe still pretty bad.

I love the first sentence but absolutely hate the next paragraph.  Count me as “deluded.”  If there is one thing I have learned from 20 years of studying the Great Depression is that THERE WOULD HAVE BEEN NO DEPRESSION AT ALL HAD PRICES NOT FALLEN.  The interwar economy was very different from ours, much more commodity-based.  And commodities were not only a large share of GDP, they were by far the most flexible and cyclical prices.  A sharp drop in aggregate output during the interwar years could not occur without a sharp drop in commodity prices.  And if the overall price level was stable, there is no way commodity prices could have fallen sharply.  They were a huge share of the WPI, (which was the only price index that policymakers paid attention to.)  Furthermore, without the deflation the banking crises of the 1930s would never have occurred.  Without deflation the 1929 stock market crash would have been exactly like the equally large 1987 crash in terms of its effect on the economy—i.e. it would have had no effect.

Part 2.  My hometown

I grew up in Madison, Wisconsin, which superficially seems a fairly ordinary city.  But if you look closely enough no place is really average, is it?  Life Magazine once named Madison the best place to live in America.  Playboy once named the UW “best party school.”  It is the second most educated city in America (I believe above 100,000 or 150,000 people.)  It produced America’s greatest visual artist (Frank Lloyd Wright.)  And its greatest claim to fame?  The Onion:

Available Labor Rate Increases to 10.2%

WASHINGTON””In what is being touted by the Labor Department as extremely positive news, the nation’s available labor rate has reached double digits for the first time in 26 years, bringing the total number of potentially employable Americans to an impressive 15.7 million.

Hilda Solis briefs the press corps on the unprecedented level of untapped manpower.

“This is such an exciting time to be an employer in America,” said Labor Secretary Hilda Solis, adding that every single day 6,500 more citizens join America’s growing possible workforce. “There’s such a massive and diverse pool of job-ready Americans to choose from. And each month the number only gets higher.”

“While our current available labor rate of 10.2 percent isn’t quite as robust as it was in 1982 or 1933, we’re happy to say that reaching that benchmark is no longer out of the realm of possibility,” Solis continued.

According to the Department of Labor’s report, nearly 200,000 more Americans suddenly became fully hirable in October alone. And November saw unprecedented gains in the number of high-quality auto workers, teachers, lawyers, part-time retailers, and even doctors who could be employed.

The report also explained that, because of the booming would-be-employee market, college graduates are having an easier time than ever joining the ranks of those ready and able to receive monetary compensation for work performed at some point.

Moreover, it found that, while all Americans were benefiting in some way from the new trend, the nation’s African Americans appeared to be in the best position to take advantage of the upward swing in potential employment, with 15.7 percent of all black citizens now situated to have a chance of becoming wage-earners someday.

“We are very lucky to be living in a time when so many people can just go out whenever they feel like it and get a job application,” Deputy Labor Secretary Seth Harris announced. “Compare that to the late ’60s or late ’90s, when the available labor rate plummeted to 4 percent and employers didn’t have their pick of millions upon millions of Americans dying to put on a hard hat or suit jacket for practically peanuts.”

Added Harris, “Those were scary times in America.”

PS.  Yes, I know The Onion moved to NYC, but it started in Madison.

PPS.  Several commenters including Malavel sent me this WSJ piece on the new FOMC members.

HT:  Michael Belongia