” . . . the FOMC chose to pursue a slow recovery.”

When I said this in 2009 I was way out on the fringe.  Today it’s almost become conventional wisdom.  And now we have a top Fed official admitting what market monetarists have known all along.  Here’s Narayana Kocherlakota:

So the FOMC was not forced to pursue a slow recovery because of constraints on its tools. Rather, the FOMC chose to pursue a slow recovery. In my view, this choice can be traced back to the Committee’s reliance on the Taylor Rule as a key baseline in its thinking. As we have seen, the Taylor Rule is specifically designed to constrain the response of the central bank’s target interest rate to inflation gaps and output gaps. Qualitatively, a desire for low interest rate variability would have important consequences for the FOMC’s perspectives on appropriate monetary policy in late 2009. To achieve a faster recovery, the FOMC would need to add more accommodation and/or slow the pace of its eventual removal of accommodation. Either option would increase the deviation between the time path of accommodation and its eventual long-run level.

The October 2009 Greenbook provides a more quantitative sense of how the Taylor Rule restricts the pace of economic recovery. In formulating its outlook, the staff assumed that, after (a delayed) liftoff in early 2012, the Committee’s future fed funds rate target choices would follow a rule that was close to that originally proposed by Taylor (1993).9 Given this model of Committee behavior, the staff’s outlook was that the unemployment rate would remain above its long-run level for nearly four years. The projected recovery was even slower with respect to inflation: It was expected to remain at or below 1.6 percent for at least the next five years.

To summarize: In the wake of the Great Recession, the FOMC and its staff treated the pre-2008 policy framework—that is, the Taylor Rule—as an important baseline. As we have seen, the Taylor Rule is grounded in an implicit penalty on deviations of short-term interest rates from their long-run levels. Because of that penalty, the rule required the Committee to seek a slow recovery in its dual mandate variables in order to return the short-term interest rate closer to its long-run level more rapidly. Put more bluntly, the Taylor Rule required the Committee to forgo the timely creation of hundreds of thousands—perhaps millions—of jobs in order to get interest rates back up to normal more rapidly.  

.  .  .

To be clear, there have been many prior suggestions about how to arrive at a better framework. Some observers have suggested that the FOMC should increase the inflation target, so as to have more policy space to deal with adverse demand shocks. Some observers have suggested that the FOMC should target the price level rather than the inflation rate. Still others have suggested that the FOMC should target the level of nominal income.

I see merit in all of these suggestions, and I welcome explorations of their consequences. But they represent large changes in the FOMC’s long-run goals. I will instead recommend a more minimal change in terms of the FOMC’s strategy—that is, how it seeks to pursue its current long-run goals. My recommendation is that the FOMC should adopt a policy framework that puts considerably more emphasis on returning the economy to its dual mandate objectives over the medium term. Such a framework would immediately imply that the FOMC should use a monetary policy reaction function that is a lot more responsive to the Committee’s best medium-term projections of inflation and output gaps.

What would be the benefits of this change in the FOMC’s strategic framework? I see two clear benefits. First, the FOMC’s choices would systematically return both inflation and output to desired levels more rapidly. There would be less persistence and less volatility in both inflation and output gaps. Second, the credibility of the FOMC’s inflation target would be enhanced. As noted earlier, in November 2009, the staff projected that, if the FOMC used the Taylor Rule after liftoff, inflation would remain at 1.6 percent or below for the next five years. This kind of outcome creates large downside risk to the credibility of the inflation target.

Those are the benefits: less variance in macroeconomic variables and enhanced credibility of the FOMC’s long-run inflation target. What would be the costs? The key cost is that, of course, the fed funds rate would be more variable around its long-run level. I have two comments about this putative cost. First, I don’t know of models in which such a cost is grounded in traditional welfare economics.10 The real interest rate is a key intertemporal price, and it may need to vary a lot to effect a desirable allocation of resources. According to models that are currently available, it would be welfare-reducing to smooth the fluctuations of this important price.

Second, and perhaps relatedly, my reading of the Federal Reserve Act is that Congress has not mandated that the FOMC seek to constrain the variability of its policy instruments. Congress has mandated that the Committee adjust its policy instruments as needed so as to achieve its macroeconomic objectives.11

To summarize my third and final point: The FOMC should strongly consider lowering its implicit penalty on interest rate variability relative to what was being imposed before the crisis. Doing so would lead the Committee to use a monetary policy reaction function that puts more weight on its forecasts of inflation and output gaps. Such a reaction function would automatically engender a more appropriate monetary policy response to severe downturns in inflation and employment such as those experienced during the Great Recession.


The theme of this speech is that the FOMC’s thinking about appropriate monetary policy in extraordinary times like late 2009 is heavily influenced by its policy framework during normal times. It should choose its new “normal” policy framework with this in mind. I have argued that the pre-2008 framework led the Committee to aim for a relatively slow recovery in inflation and employment in the wake of the Great Recession. I’ve recommended that, going forward, the Committee should use a reaction function that would be considerably more responsive to its best available forecasts of inflation and output gaps.

The U.S. House recently passed a measure, the Fed Oversight Reform and Modernization Act, that would enshrine the Taylor Rule as a key benchmark for monetary policy. Federal Reserve Chair Janet Yellen recently wrote in a letter12 to House leaders that the bill “would severely impair the Federal Reserve’s ability to carry out its congressional mandate to foster maximum employment and stable prices and would undermine ability to implement policies that are in the best interest of American businesses and consumers.”

My argument today gives a concrete example of Chair Yellen’s criticism. The FOMC did treat the Taylor Rule as a key benchmark for monetary policy during the early part of the recovery from the Great Recession. By doing so, we were systematically led to make choices that were designed to keep both employment and prices needlessly low for years.

Ultimately, if this legislation were to become law, it would force the Federal Reserve into the same kinds of choices in the wake of future adverse shocks. [Emphasis added]

Unfortunately, Kocherlakota is flat out wrong about the recent House bill, it does not “enshrine the Taylor Rule as a key benchmark for monetary policy”.  Not even close.  It asks the Fed to come up with an explicit monetary rule.  I suggest NGDPLT, target the forecast.

Otherwise a great speech, just outstanding.

HT:  TravisV, Julius Probst



30 Responses to “” . . . the FOMC chose to pursue a slow recovery.””

  1. Gravatar of E. Harding E. Harding
    5. December 2015 at 16:05

    “Today it’s almost become conventional wisdom.”

    -Nope. It’s become discussable in some mainstream circles. That’s hardly “almost become conventional wisdom”. It’s conventional wisdom when 55% or more Fed officials, economists, and Fed economists accept it.

  2. Gravatar of Benjamin Cole Benjamin Cole
    5. December 2015 at 16:06

    Excellent speech, excellent blogging.

    And yet, I wonder if the entire monatarism community is getting a little fussy. If the Fed had been “too loose” in 2008, what would have been the cost? A core PCE inflation rate of 3-4 percent? So what?

    We know the cost of a central bank that is too tight. It is extended recessions, and a public that seeks the security of socialism. With justification, btw. If central bankers rhapsodize about 0% Iinflation….

    A central bank, facing recession, should shoot for Full Tilt Boogie Boom Times in Fat City. Print more money until the plates melt.

  3. Gravatar of Britonomist Britonomist
    5. December 2015 at 16:26

    “It asks the Fed to come up with an explicit monetary rule. I suggest NGDPLT, target the forecast.”

    We all know that won’t happen; it’s going to be a Taylor rule or something similar and it will be horrible.

  4. Gravatar of Michael Byrnes Michael Byrnes
    5. December 2015 at 16:43

    A former Fed official, replaced by another Hawk. 🙂

  5. Gravatar of Negation of Ideology Negation of Ideology
    5. December 2015 at 17:02

    Off topic, but I bought the book today and read to the end of the Introduction. I think it’s great so far – easy to understand.

    One question I have is about the 5 “Wage Shocks”. I understand why they are important, but doesn’t the Sumner Critique apply to them just as much as to fiscal policy? Is there some reason the Fed can’t offset bad wage policies?

    And since I haven’t gotten to that chapter, a fair answer is simply to say “Read the book, it’s in there.”

  6. Gravatar of marcus nunes marcus nunes
    5. December 2015 at 17:12

    Scott, Bernanke had the gall to give himself an A- for his post crisis handling of things!

  7. Gravatar of ssumner ssumner
    5. December 2015 at 17:32

    Britonomist, I see almost zero chance that the Taylor Rule will be officially adopted by the Fed.

    Michael, He’s still a Fed official.

    Negation. The “Sumner Critique” (which is just standard macro circa 2007) doesn’t apply to the gold standard, or at least doesn’t fully apply.

    Marcus, When precisely is “the crisis”?

  8. Gravatar of marcus nunes marcus nunes
    5. December 2015 at 18:04

    According to Bernanke´s definition:
    “I think that I wouldn’t give us a particularly good grade before the fall of 2007. After that, when we began to see what was going on, there, we were much more aggressive in responding.”
    So, it´s even worse than I though! He things they did rather well from end 2007 onwards!

  9. Gravatar of Ray Lopez Ray Lopez
    5. December 2015 at 18:09

    Sumner: “Britonomist, I see almost zero chance that the Taylor Rule will be officially adopted by the Fed.” – but the 30% or so chance some Republican gets elected President might change that? The Republicans and Taylor are close, already they sponsored bills to enshrine the Taylor Rule as policy. Not that it matters of course (money is neutral).

  10. Gravatar of Major.Freedom Major.Freedom
    5. December 2015 at 20:41

    This entire blog post is completely wrong.

    The “recovery” was slow because of the Fed NOT letting the corrections to occur. What would have otherwise been a very steep, very painful, very deflationary, but much shorter recovery, turned into a modestly steep, modestly painful, modestly deflationary, and prolonged slump, because of higher than market inflation brought about by central banks.

    It is wrong to believe that because price inflation was 1%, or that the NGDP increase was 2%, that the somehow proves there was not enough inflation. The optimal outcome is not what the Fed says it is, nor what Sumner says it is, but what the market process determines it to be. Deviations away from this are “too much” and “too little”.

    Kocherlakota cannot possibly “admit” what market monetarists “knew all along”, because one cannot admit a falsehood, nor can one “know” a falsehood as if it were true.

    The fundamental error in Summer’s worldview is what his standard is not individual action, but political coercion.

  11. Gravatar of Gene Frenkle Gene Frenkle
    5. December 2015 at 21:12

    The recovery was always going to be slow because so many Americans built up irresponsible levels of personal debt during thr 2000s. I would have to say the Obama welfare expansions that were part of the stimulus probably did the most to undermine the economy. It is NOT a coincidence that the job market only picked up once the welfare expansions expired around the beginning of 2014.

  12. Gravatar of ChrisA ChrisA
    5. December 2015 at 23:35

    Simple incentives at work. In the eyes of most the Fed is not responsible for economic performance only inflation. So the Fed did what every person with a performance target does, focussed on beating their performance target by erring on the low side of inflation, and never mind the other consequences. What gets measured gets done. Hence the need to change their target.

  13. Gravatar of James Alexander James Alexander
    6. December 2015 at 00:29

    The interview had Bernanke saying the Great Depression was a monetary crisis that caused a banking crisis.

    And that the Great Recession was a banking crisis, starting with BNP’s fund suspensions in 2007, caused by wild bankers inadequately regulated by the Fed, hence the C-.

    The A- was because the Fed bravely organised the rescue of the banks but possibly didn’t do monetary policy so well, otherwise an A+ (though he doesn’t say this himself).

  14. Gravatar of Max Max
    6. December 2015 at 02:48

    Realistically, there could be a tradeoff between economic stability and a fast recovery.

    If the real options are:
    (1) fast recovery, followed by overshooting and recession
    (2) slow recovery, but with an unusually long period of stability
    …it’s not clear which is better.

  15. Gravatar of TravisV TravisV
    6. December 2015 at 09:22

    “The Inside Story Why The ECB Decided “The Markets Needed To Be Disappointed” And How It All Fell Apart”



  16. Gravatar of Richard A. Richard A.
    6. December 2015 at 09:38

    What Kocherlakota is indirectly saying is that an expansive fiscal policy would have been neutralized by the FOMC.

  17. Gravatar of Scott Sumner Scott Sumner
    6. December 2015 at 10:28

    Gene, You said:

    “The recovery was always going to be slow because so many Americans built up irresponsible levels of personal debt during the 2000s.”

    Why would large levels of debt make Americans want to take long vacations? I’d want to buckle down and work harder if I had large debts. The real problem was lack of AD, i.e. monetary policy.

    Extended unemployment did have an effect, but it was rather small.

    James, Of course the Great Recession has more similarities to the GD than Bernanke realizes.

    Max, As we saw in the 1980s, those are not the only two options.

    Richard, I wish you were right, but that’s not the way I read it.

  18. Gravatar of Gene Frenkle Gene Frenkle
    6. December 2015 at 11:40

    ssumner, I went on actual vacations and went out to nice restaurants in 2008-09 and the hotels and restaurants were empty. The owners and waitstaff were complaining about how “dead” it was. People did hunker down and I even met some young people that got caught up in the Housing Bubble and ended up underwater in their homes and were essentially prisoners. So prior to the Bubble bursting people were much more mobile and when they moved they could get a job waiting tables while looking for a career job…that avenue dried up overnight.

  19. Gravatar of Scott Sumner Scott Sumner
    7. December 2015 at 16:53

    Gene, I think you missed my sarcasm.

  20. Gravatar of Scott Sumner, the Rortyian Historian Scott Sumner, the Rortyian Historian
    8. December 2015 at 09:01

    […] But Scott Sumner likes the FORM Act–it’s a move in the direction toward a “discretion-free, let-the-markets-target-NGDP-growth” rule–and so he doesn’t want anybody criticizing it. So in response to Kockerlakota’s statement, Sumner wrote: […]

  21. Gravatar of Gary Anderson Gary Anderson
    8. December 2015 at 23:39

    So, if inflation was rampant, wouldn’t the banks who lend at low rates become the new S&L’s, if rates were severely raised? Wouldn’t they fold or need massive bailouts?

    I am not an economist and don’t claim to be, but economists are not answering some questions that I have.

    Don’t the banks bet on low interest rates as a general rule, and if inflation took off, the need to raise rates severely would be off the table to protect those banks?

  22. Gravatar of ssumner ssumner
    10. December 2015 at 17:35

    Gary, You said:

    “Don’t the banks bet on low interest rates as a general rule, and if inflation took off, the need to raise rates severely would be off the table to protect those banks?”


  23. Gravatar of Gary Anderson Gary Anderson
    10. December 2015 at 23:34

    So, I say banks do bet on low interest rates. That is why they require that borrowers take the higher fixed side of the bet in the derivatives they issue. The banks take the low, floating side of the bet. Interest rate swaps are a huge market.

    And you say raising rates severely would not hurt the banks. We know that policy of Volcker crushed the S&L’s.

  24. Gravatar of ssumner ssumner
    11. December 2015 at 08:44

    Gary, You said:

    “And you say raising rates severely would not hurt the banks.”

    Oh really, where did I say that?

  25. Gravatar of Gary Ajnderson Gary Ajnderson
    11. December 2015 at 09:08

    Scott, that is assumed in your talking about the need for the Fed to speed up the recovery. You know that if the recovery became white hot, that interest rate rises could be required to put on the breaks to that. I just assumed that was your position.

    By the way, you are onto something here when you say the Fed just chose to pursue a slow growth plan. Exactly. They could have sped things up. They chose not to because they assumed inflation would speed up anyway? Or it was a conspiracy? I wonder why they did that? I have no idea why they did that.

    But I think the original housing bubble was a conspiracy by the central banks. They got for their banks fees for loans that could not be repaid, the houses were reclaimed in foreclosure, and they got bailout money and retroactive guaranteed loans. What a sweet deal that was.

  26. Gravatar of HR Puffnstuff HR Puffnstuff
    11. December 2015 at 13:08

    “That is why they require that borrowers take the higher fixed side of the bet”

    Gary, maybe I just don’t understand these things, but wouldn’t taking a 5 yr arm on a home make me the one taking the lower floating side of the bet?

  27. Gravatar of Gary Anderson Gary Anderson
    13. December 2015 at 00:15

    Hi HR. Yes, true in RE, but in business, the companies want out of adjustable risk and prefer a little higher rate with as long as it is fixed. So, in business, the banks have bet on low rates, by taking the floating side of the bet.

  28. Gravatar of ssumner ssumner
    13. December 2015 at 06:03

    Gary, Given you know absolutely nothing about economics, it’s best if you don’t “assume” you know what I’m talking about. I can assure you based on our many conversations that you don’t have a clue as to what I’m talking about. I might as well be speaking Greek.

  29. Gravatar of Gary Anderson Gary Anderson
    13. December 2015 at 13:28

    I apologize, Scott. However, I view the go slow Fed as a conspiracy of sorts, to protect the banks. You may come to that view someday, and really, it isn’t a question of economics, but rather of politics and power.

    But there is an economic aspect that you probably don’t study, and that is the new demand for long bonds, that is required due to the new clearing houses in the derivatives markets. The demand is massive, Scott, and messes with historical measures that economists use regarding the behavior of bonds. Debt is turned into gold, as collateral for derivatives. That use for long bonds is increasing yearly. And the following economist appreciated my treatment of his article, as I attempted to make sense of it: http://www.talkmarkets.com/content/us-markets/will-fed-and-central-bankers-give-up-alchemy-to-save-the-world?post=74282

  30. Gravatar of Don Geddis Don Geddis
    13. December 2015 at 18:53

    @Gary Anderson: I read your blog post. It was terrible. You start off with a framework filled with unsupported and false claims, and then you end with a non-solution to a non-problem. Really shoddy attempted analysis.

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