The Fed fesses up (What will my critics say now?)

In my previous post I suggested that the Fed was looking for an excuse to ease.  Here is some evidence from the WaPo:

Federal Reserve officials, increasingly concerned over signs the economic recovery is faltering, are considering new steps to bolster growth.

And here is the connection to fiscal policy:

With Congress tied in political knots over whether to take further action to boost the economy, Fed leaders are weighing modest steps that could offer more support for economic activity at a time when their target for short-term interest rates is already near zero. They are still resistant to calls to pull out their big guns — massive infusions of cash, such as those undertaken during the depths of the financial crisis — but would reconsider if conditions worsen.

God I hope QE isn’t the “big guns.”  The real “big guns” would be a higher price level target.

Top Fed officials still say that the economic recovery is likely to continue into next year and that the policy moves being discussed are not imminent. But weak economic reports, the debt crisis in Europe and faltering financial markets have led them to conclude that the risks of the recovery losing steam have increased. After months of focusing on how to exit from extreme efforts to support the economy, they are looking at tools that might strengthen growth.

Hmmm.  I seem to recall that a few months back it was us no-nothing bloggers who were saying we don’t need an exit strategy; we need an entrance strategy.  On the other hand those “scientific” economists at the Fed were ignoring market signals and pressing ahead with their anti-inflation strategies.  It looks like we were right.

And how about this:

One pro-growth strategy would be to strengthen language in Fed policy statements that the central bank’s interest rate target is likely to remain “exceptionally low” for an “extended period.” The policymakers could change that wording to effectively commit to keeping rates near zero for even longer than investors now expect, perhaps adding specifics about which economic conditions would lead them to raise rates. Such a move would be opposed by many members of the Fed policymaking committee who are wary of the “extended period” language, arguing that it limits their flexibility.

Those are actually two very different policy ideas, although it might not look so at first glance.  Low interest rates as far as the eye can see is actually tight money, as Nick Rowe pointed out in the comment section of one of his recent posts:

Scott: thanks! I know what you mean about the difficulty of expressing one’s views when the “dominant narrative”(? Oooh!) makes them sound nonsensical. “I want the Bank of Canada to loosen monetary policy by doing things that would raise nominal interest rates”. What?!

Exactly, and I want the Fed to raise interest rates by setting a much higher price level or NGDP target.  But alas, the Fed seems horribly confused about this issue.  Only if the period of zero rates was linked to economic conditions in such a way as to increase inflation expectations, would the policy have any stimulative effect.  I’ll address this issue in another post later today.  Fortunately, they do have some good ideas:

Another possibility would be to cut the interest rate paid to banks for extra money they keep on reserve at the Fed from 0.25 percent to zero. That would give banks slightly more incentive to lend money to customers rather than park it at the Fed, although it also could cause technical problems in the functioning of certain credit markets.

For 18 months I have been bashing the Fed’s interest on reserve program.  And a zillion commenters have insisted I don’t know what I am talking about.  “The Fed knows what it is doing better than you Sumner.”  “They would never adopt a contractionary policy during a severe recession.”  “It’s all in your imagination.”  OK, but isn’t this an admission that a lower IOR would be expansionary?  Robert Hall and Susan Woodward were right last year.  The Fed’s policy was contractionary, and still is.  But perhaps this is just the WaPo, do we have any evidence that the Fed thinks that unconventional tools might help?

Fed officials express confidence that they have tools to address the economy further if conditions worsen.

“I think we do have a variety of tools available, and we shouldn’t rule any tool out,” Eric Rosengren, president of the Federal Reserve Bank of Boston, said in an interview. “If we’re uncomfortable with how long it’s going to take us to reach either element of our dual mandate [of maximum employment and stable prices], we’ll have to make some adjustments to policy.”

. . .

“If the economic situation changes, policy should react,” James Bullard, president of the Federal Reserve Bank of St. Louis, said in an interview Wednesday. “You shouldn’t sit on your hands. . . . I think there’s plenty more we could do if we had to.”

I agree, but also find the Bullard quotation to be rather strange.  The executive and legislative branches are literally pulling out their hair trying to think of stimulus packages that won’t blow up the deficit.  And here is Bullard basically saying, “Yeah, we could do “plenty” more to boosting AD without increasing the deficit by one cent, but we don’t want to.  How did the world’s greatest power get into a position where there appeared to be an easy way out of 9.5% unemployment, but we weren’t doing it solely because of an independent central bank?  And don’t tell me there are other reasons why AD might not solve our problems.  That’s not what I said.  I said Congress and the president think more AD would solve our problems.  If they could boost AD without increasing the deficit they would do so in a heartbeat.  The US isn’t refraining from additional stimulus because Obama, Reid and Pelosi are sudden converts to freshwater economics, we are refraining from boosting AD because they do not control the only policy tool that is able to do so without blowing up the deficit.

PS.  I don’t like to use profanity here.  But if Obama and Congress understood the meaning of Bullard’s statement (which is unlikely) they would probably interpret it as the Fed blowing them a giant F*** ***.  I’m sure Bullard didn’t mean it that way, but I don’t see any other interpretation.

HT:  JimP, malavel



18 Responses to “The Fed fesses up (What will my critics say now?)”

  1. Gravatar of Doc Merlin Doc Merlin
    8. July 2010 at 12:41

    Slightly off topic but a thought:

    One though, if nominal rigidity is from money illusion and from prices and wages, then inflation targeting or NGDP growth targeting should be fine. If nominal rigidity comes from debt then explicit NGDP level targeting of some sort is needed because debt rigidities are over much, much longer time scales.

  2. Gravatar of Doc Merlin Doc Merlin
    8. July 2010 at 12:42


  3. Gravatar of Gregor Bush Gregor Bush
    8. July 2010 at 13:22

    “Only if the period of zero rates was linked to economic conditions in such a way as to increase inflation expectations.”

    Scott, I think this is implicit in the Fed’s idea. It is along the lines of the Bank of Canada’s “conditional commitment” that they stated including in their policy statements in early 2009. You might ask “why did the BoC need to do this if they already had an explicit inflation target”. Well, it’s because the Bank looked at private sector forecasts and realized that market participants were expecting them to raise rates despite weak growth and falling inflation and this expectation was leading to forecasts of near zero inflation two years out. Markets for some reason thought that the Bank would want to raise rates quickly once the crisis was over and that this tightening would further weaken the economy. The “conditional commitment” was the Bank’s way of reminding markets that it runs policy to hit its inflation objective does not to ‘renormalize’ rates just for the sake of doing so.

    If you look back to the middle of 2009, I think the Fed had a similar problem. TIPS markets were indicating below target inflation for 5 years yet the market was, for some reason, expecting substantial hikes in the Fed funds rate in 2010. I think a conditional commitment would have helped the Fed loosen monetary policy at that time. I think it could still be effective now but perhaps less so now.

    What if they signaled that they would raise rates until core inflation moved above 1.7% (currently 0.9% and falling) or the unemployment rate moved below 7% (currently 9.5%). That would investors/business/consumers that at some point in the future there’s going to have to be a long period of fast growth, rising inflation (yet still low) and the policy rate still at zero. Hey, come to think of it, that will be a great environment for equity returns – I’m going to buy right now (you see, it’s working already).

  4. Gravatar of Benjamin Cole Benjamin Cole
    8. July 2010 at 13:29

    I read that Bullard quote also, and was very unimpressed. Oh really, you could do more, if you “had to”?
    And just what circumstances would impel you to actually change your name from Mr. Do Nothing?
    Bullard, and other Fed chieftains, seem to be letting their politics and shibboleths define their policies, not the practical needs of today.

    BTW, this blogger says the new board chieftains may be more “activist.” See:

    Maybe so. I have the uneasy feeling that new people in the Fed gang always have a need to show they are “tough on inflation” first, kind of like when you first join up with street hoodlums, and have to overreact to a perceived threat, to show you are tough. You need street cred.

    But for now, the Fed should remember that full employment is one-half of their mission. The other is price stability–and there is no threat of inflation for years ahead.

  5. Gravatar of Ben Crain Ben Crain
    8. July 2010 at 13:34

    You write: “God I hope QE isn’t the “big guns.” The real “big guns” would be a higher price level target.” Aren’t you confusing tool and target? A higher price level is certainly a target. (Whether good or bad I leave to one side, for purposes of this comment.) And QE is certainly a tool. Though a rather confusing tool, from the references I’ve seen to what it means: direct central bank purchases of assets (bonds). It’s confusing because that’s exactly how economic texts depicted monetary policy, back in the day when I read such texts. (Have they changed?) The bonds purchased were always described as gov bonds. Hasn’t QE (or QT, for tightening) been standard, in that sense, since forever? The degree of QE(QT) might be controversial (too much is “monetizing” the gov debt (bad), just the right amount is “controlling the money supply or interest rates (good)). But surely the method is not controversial, at least for the purchase of gov bonds. Or does QE mean the purchase of non-gov bonds? If so, the controversy should be over the appropriateness of monetizing private sector debt, not its usefulness as a monetary policy tool. I would appreciate clarity on this question.

    Whatever is meant by QE, it’s a tool. A higher price level, or higher NGDP, is a target. Your comment conflates the two, unless you mean something like: The Fed could just decide to ramp up QE without any target/objective in mind, other than “boosting the economy”. Bad. Or it could adopt a price level/NGDP target, then try to employ the best tools (including, inter alia, an appropriate degree of QE) to achieve that target. Good. Except for the nagging suspicion that its ability to match tool to target might be so poor that just picking a (large) QE number out of the hat would have as much chance of success as a disciplined, analytical approach.

  6. Gravatar of ssumner ssumner
    8. July 2010 at 14:38

    Doc Merlin, Yes, I think that is right. A long time ago I wrote a paper suggesting that long term nominal debt could also explain slow adjustments in nominal money demand.

    Gregor, I think the smarter people at the Fed have that in mind, but the Fed itself is far from actually doing that. Indeed I think it is more likely to do the ineffective option. And the “economic conditions” must be levels, not rates. It does no good to say we won’t raise rates until inflation hits 2%, if the public doesn’t expect inflation to hit 2% for many years. Japan is a cautionary case. Low interest rates can coexist with low inflation for a long time. If the BOJ was level targeting, they’d be shooting for 16% inflation in 2011. I fear that if they don’t do level targeting, it won’t be enough.

    Benjamin, Good points, but as the Japanese case shows you also need “street cred” when fightning against deflation.

  7. Gravatar of Mike Sandifer Mike Sandifer
    8. July 2010 at 15:41


    Maybe there’s something you can do about this. Perhaps you, and /or some like-minded economists, can start a drive to get as many economists as possible to sign a letter to the Fed supporting more easing.

  8. Gravatar of Jeff Jeff
    8. July 2010 at 18:07

    You’re assuming that the authorities want the economy to grow. But maybe they just want to increase their own power, and they think a bad economy will help them do that. Like the principle of comparative advantage, the brand of monetary economics you’ve been preaching here is actually pretty conventional, and it’s not hard to understand. Yet we see politicians and their media lackeys call for trade restrictions all the time.

    You think that even if what I’m suggesting is true, educating the public will result in political pressure to adopt better policies. But I look at what’s happening in Arizona and wonder if the masses will ever get anything right. Still, I suppose we gotta keep trying.

  9. Gravatar of Talking Up Deflation | Talking Up Deflation |
    9. July 2010 at 05:15

    […] to use it. “The real ‘big guns’ would be a higher price level target,” he opines. “I want the Fed to raise interest rates by setting a much higher price level or [nominal GDP] […]

  10. Gravatar of A reduction in both fiscal and monetary stimulus | Credit Writedowns A reduction in both fiscal and monetary stimulus | Credit Writedowns
    9. July 2010 at 05:30

    […] -The Fed fesses up (What will my critics say now?) […]

  11. Gravatar of Talking Up Deflation Talking Up Deflation
    9. July 2010 at 05:57

    […] to use it. “The real ‘big guns’ would be a higher price level target,” he opines. “I want the Fed to raise interest rates by setting a much higher price level or [nominal […]

  12. Gravatar of Matthew Yglesias » James Bullard Should Act Right Now Matthew Yglesias » James Bullard Should Act Right Now
    9. July 2010 at 07:30

    […] think Scott Sumner needs to master the art of the short blog post because this one really buries the lead. He pulls up a very strange remark that James Bullard apparently made to […]

  13. Gravatar of thruth thruth
    9. July 2010 at 11:48

    Scott: Slightly off topic, but this post is as good as anywhere to put it. I finally caught your first podcast with Russ Roberts on your monetary policy views (from last November). I thought that the conversation between the two of you was very good. Almost all of your ideas came across clearly and Russ did a good job of helping you to clarify the few points that didn’t. Russ also did a nice job of contrasting your view with competing views. Great stuff.

    I highly recommend this podcast to anyone who isn’t already familiar with Scott’s views. It’s also a good recap with some interesting tidbits for regular readers who haven’t heard it yet. Here’s the link:

  14. Gravatar of Doc Merlin Doc Merlin
    9. July 2010 at 12:21


    “But I look at what’s happening in Arizona and wonder if the masses will ever get anything right. ”

    What is amusing is that Rhode Island and Hawaii have similar laws, but they don’t get any flack from the left for it. This makes me think that the anti-immigration sentiment is very broad spectrum in US politics. 🙁

  15. Gravatar of scott sumner scott sumner
    9. July 2010 at 15:30

    Mike, I tried that last year and almost no one signed. But I am considering trying again.

    Ben, A higher price level is a target. But a higher price level target is a tool. It is a tool that changes expectations, and makes the given interest rate and monetary base more expansionary.

    The Fed generally buys government bonds, which I think is appropriate.

    Jeff, I am pretty sure that Obama and the Congressional Dems want growth, as they are about to be decimated in the fall elections.

    thruth, Thanks, I will recommend the podcast to some of the newer commenters who have trouble figuring out where I am coming from.

    Doc Merlin, Yes, I just found that out about Rhode Island. I am pro-immigration, but when I read about the Arizona law I had a hunch there was less there than many people assumed. If Rhode Island has been doing that for years, then it may not be that big an issue. But I must plead ignorance–I am too invested in money right now to keep up with other policy issues.

  16. Gravatar of Jeff Jeff
    12. July 2010 at 07:26

    Scott, if that’s true, then how do you explain the failure to make timely appointments of people who think like you to the Federal Reserve Board? Anyone who didn’t sleep through all of their macro classes knows that monetary policy is at least as powerful as fiscal policy, easier and faster to implement, and doesn’t need 535 individual egos to agree with it. This failure is inexplicable only if you think economic growth is the Administration’s goal.

    The Democrats are going to lose a lot of seats in November, but they’re playing a longer-term gain. After a few years, expensive entitlements become sacred cows that all politians genuflect to. Social Security is the prime example, but notice that none of our supposed “fiscal conservatives” in either party are calling for repeal of Bush’s prescription drug coverage additions to Medicare. And that’s less than a decade old.

    When everyone is on one dole or another (think health care), big government cannot be undone, and the Republican platform will be reduced to saying “we can do it cheaper”, which won’t win many elections.

    Here’s another point to consider: despite a terrible economy, bad mistakes in the Gulf oil spill response, an unpopular health care bill, continuing carnage in Iraq and Afghanistan, the non-closing of Gitmo, and the usual share of scandals, this president is still much more popular than his predecessor. Could it be that the Democrats actually know what they’re doing?

  17. Gravatar of ssumner ssumner
    12. July 2010 at 10:00

    Jeff, How about ignorance? Has Larry Summers publically said that monetary policy is out of ammunition at zero rates? And he’s Obama’s main economic advisor.

    If they wanted to do health care in a way the Republican’s couldn’t repeal it, they did it the wrong way. It would be hard to turn the UK system into the Singapore system, it would be much easier to turn private health insurance into the Singapore system.

  18. Gravatar of I Become A Non-Liberal For Once » The Edge of Shadow I Become A Non-Liberal For Once » The Edge of Shadow
    14. July 2010 at 15:44

    […] I’d agree with Chait (and I do, technically), but I’d much rather the Federal Reserve do what it should be doing, instead of pussyfooting around, and fix the economy which would return us to economic growth […]

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