Tim Duy discusses the evolving views of Fed Governor Powell

Tim Duy has a very good new post, showing how Jerome Powell is moving in a more dovish direction.  The following quotation is Powell, with the remark about the flat Phillips curve being Tim:

When I was first exposed to macroeconomics in college, more than four decades ago, the view was that inflation was strongly influenced by the amount of slack in the economy. But the relationship between slack and inflation has weakened substantially over the years.

Or, in other words, the Phillips Curve is flat. Not quite flat as a pancake, but pretty darn flat. More important:

In addition, inflation depends importantly on the inflation expectations of workers and firms. A widely shared view among economists today is that, unlike during the 1970s, expectations are no longer heavily influenced by fluctuations in inflation, but are fairly constant, or anchored. For both these reasons, inflation has become less responsive to cyclical changes in the economy.

I’d go even further.  The Phillips curve is not useful because it is NGDP, not inflation, that best explains how nominal and real variables are related. And the causation goes from the nominal to the real (NGDP to unemployment) not the real to the nominal (unemployment to inflation).

Once again, here’s Powell, with a follow-up comment by Duy:

I am often asked why rates remain so low now that we are near full employment. A big part of the answer is that, at least for the time being, the appropriate level of rates is simply lower than it was before the crisis. As a result, policy is not as stimulative as it might appear to be. Estimates of the real interest rate needed to keep the economy on an even keel if it were operating at 2 percent inflation and full employment–the “neutral rate” of interest–are currently around zero. Today, the real short term interest rate is about negative 1-1/4 percent, so policy is actually only moderately stimulative. I anticipate that the neutral rate will move up over time, as some of the headwinds that have weighed on economic growth ease.

The Fed increasingly recognizes that policy is not highly accommodative simply because rates are zero. The stance of policy is relative to the real interest rate, and a lower real rate means that policy is actually only “moderately” stimulative. Translation: There is no need to hike rates soon because policy is not particularly accommodative.

Of course market monetarists have been saying  that low rates don’t mean accommodative policy ever since 2008.  I’d go even further.  Not only is the current policy not as accommodative as it seems, it’s not accommodative at all.  NGDP growth (or inflation) are likely to undershoot the Fed’s goals.

Over the period since 2009, we’ve seen macroeconomic discourse evolve as follows:

1.  NGDP may be a more useful indicator of nominal conditions than inflation.

2.  The Phillips Curve is not very useful.

3.  Low interest rates do not imply that money is easy.

4.  Expansionary fiscal policy may be offset by an inflation targeting central bank.

5.  The zero lower bound does not prevent negative IOR.

6.  At the zero bound, a premature increase in interest rates will lead to lower interest rates in the long run.

Of course no one has a monopoly on these views, but which set of bloggers were most forcefully making these points in early 2009?

With the post-Brexit vote plunge in global bond yields, any doubts that low rates are the new normal are gone.  The Fed’s been much slower than the markets to understand this new reality, but they aren’t stupid.  At some point the Fed will realize that its preferred (“conventional”) policy tool simply doesn’t work.  Rates will immediately fall to zero in all future recessions, so “conventional” monetary policy will be useless.  How will the Fed react:

1.  NGDP targeting

2.  A higher inflation target

3.  Level targeting

4.  Miles Kimball’s negative IOR plan

5.  Throw up their hands and ask for support from fiscal policy

I hope and pray they don’t choose option #5. Because it won’t work.

PS.  Tyler Cowen just reported that Swiss yields are negative out to 50 years.  That’s why I opposed the Swiss decision to revalue the franc upward last year.  The upward revaluation was motived by a fear of inflation (and no, I’m not kidding.)

HT:  David Levey



20 Responses to “Tim Duy discusses the evolving views of Fed Governor Powell”

  1. Gravatar of Ray Lopez Ray Lopez
    2. July 2016 at 11:15

    Sumner: “Of course no one has a monopoly on these views, but which set of bloggers were most forcefully making these points in early 2009?” – I don’t know. Surely it’s not you?

    Sorry I missed your views on just printing money by the Fed and handing it to the US Treasury to spend. What is your view again?

  2. Gravatar of ssumner ssumner
    2. July 2016 at 12:21

    Ray, Come back here when you figure out what an AS/AD model looks like.

  3. Gravatar of Gary Anderson Gary Anderson
    2. July 2016 at 16:31

    Fascinating article. The Fed are do nothing New Monetarists. They will, if we read Stephen Williamson correctly, just let things go negative as to bond yields. They won’t do negative IOR. That could upset the slow growth scenario.

    They like really slow growth because, I believe, they know they cannot raise interest rates in a white hot economy or all the collateral in the world will suddenly go bad. JMO. That is why they will never go for serious stimulus. Again, JMO as an observer.

  4. Gravatar of bill bill
    2. July 2016 at 16:38

    I just had a thought. Maybe the Lower Bound would be -2% on a 50 year bond? The investor hands in money today to buy the bond and never gets any money back. (i.e, 50 times -2% = -100%).
    Just kidding.

  5. Gravatar of Benjamin Cole Benjamin Cole
    2. July 2016 at 16:57

    #5 Fiscal policies. Of late we see more acceptance of what was once called “helicopter drops” or what is now called “money financed fiscal programs” as a way out of this eternal slow growth, zero inflation, low interest rates trap.

    Michael Woodford, Lord Adair Turner and possibly even Raghuram Rajan are in this camp.

    The great Japanese Finance Minister Takahashi Korekiyo helped Japan sidestep the brunt of the Great Depression through the Innovative use of money financed fiscal programs.

    Surely structural reforms are in order. But the supply side is flooded, globally. I cannot think of a single industry straining to meet demand.

    Why should governments and taxpayers in incur deepening debts and obligations just to appease obsolete financial theories and nostrums?

    Go to the helicopter drops—no, scratch that. Send the B-52s.

  6. Gravatar of Major.Freedom Major.Freedom
    2. July 2016 at 17:36

    The Phillips curve is not useful because it is NGDP, not inflation, that best explains how nominal and real variables are related. And the causation goes from the nominal to the real (NGDP to unemployment) not the real to the nominal (unemployment to inflation).

    Unemployment is not the sole “real” variable that underlies the causation relationships between real and nominal variables though. In addition, it is not true that aggregate nominal variable changes “cause” changes to aggregate real variables, or vice versa. In the aggregate, both real and nominal variables are caused by hampered individual subjective valuations and activity.

    Just because there is a centralized monopoly that could in principle print whatever quantities of money that raises NGDP at a (non-market) growth rate, that doesn’t mean money all of a sudden becomes a variable that causes change to real variables (again in the aggregate).

    Yes, it is rather awkward to say in a world of centralized banking that real variables cause changes to nominal variables. After all, the central bank is the cause of nominal aggregate changes, so it would seem that if there is any causation relatiinship, it would have to go from nominal to real.

    However, just because we cannot say that real variables cause nominal variables (in the aggregate), that doesn’t mean we are forced to then conclude there must be nominal variables causing changes to real variables. We can say neither take place.

    Suppose a hypothetical world where all real production was monopolized by a state, and that money was market driven. The reverse, so to speak, of our world. Use any money you want, but you have to buy the output directed by the state.

    In this scenario, it would be awkward to say that nominal variables cause changes to real variables (in the aggregate), since aggregate supply and employment is directed by the state. But does this mean that we have to then conclude that real variables in the aggregate cause changes to nominal variables in the aggregate? No, it does not. They are still co-determined. Well, the reason why it does not is the same reason why we do not have to conclude that nominal variables in the aggregate causes changes to real variables in the aggregate, in our actual world! In our actual world, aggregate nominal and aggregate real variables are co-determined. Printing money does not bring about iPads. If it did, then inflationary ancient Rome under Emperor Diocletian would have had the same output per capita as our society today. They just had to devalue the coins to a sufficiently high degree that electricity is caused into existence.

  7. Gravatar of Gary Anderson Gary Anderson
    2. July 2016 at 18:02

    I agree with you @Benjamin. I wrote about Eric Lonergan. Helicopter money is often misunderstood. The link to the article is at my name.

  8. Gravatar of Benjamin Cole Benjamin Cole
    2. July 2016 at 20:52

    On money-financed fiscal programs (which worked in Japan in the Great Depression):

    It is often claimed that monetizing fiscal deficits will result in excessive inflation. It is simultaneously argued that monetary financing will not stimulate demand.

    Get it?

    BTW, Japan is reporting their tightest labor markets in 24 years, and deflation. So why are the Fed, and the US policy-making class, agonizing about 5% unemployment?

    Why does the US have an explicit federal policy to make sure at least one in 20 US workers is involuntarily unemployed—while at the time histrionic editorials are written vilifying the minimum wage?

    And then jibber-jabber about “labor shortages”?

    Is all macroeconomics just politics-in-drag?

  9. Gravatar of Matthew Waters Matthew Waters
    2. July 2016 at 21:46

    “Surely structural reforms are in order. But the supply side is flooded, globally. I cannot think of a single industry straining to meet demand.”

    This looks much more like Say’s Law/General Glut than a true supply-side issue. If all industries are straining to meet demand, then the issue is each industry isn’t demanding enough from other industries.

    Classical Econ 101 has no notion of either “overbuilt industries” or “labor shortages.” Except for the extreme case of Cowen’s Zero Marginal Product, there is simply no Econ 101/Say’s Law case of idle labor or capital.

    On the general fiscal vs. monetary point, I don’t get the point. Japan only would need direct fiscal monetization if the equivalent monetary policy is somehow unpalatable or worse than the helicopter money drops. There is no real reason monetary policy could not accomplish the same thing. Negative rates on excess reserves plus the Fed simply restricting the printing of paper cash.

    I’m not saying the stuff will be politically easy, but all arguments for fiscal intervention amount to “the monetary equivalent would not be politically feasible” rather than “the monetary equivalent would be impossible.” The monetary equivalent has never really been impossible, and the monetary equivalent would probably be less distortionary than the fiscal policy.

  10. Gravatar of Ray Lopez Ray Lopez
    3. July 2016 at 01:06

    I see a trend developing. The intolerant Scott Sumner refuses to answer Major Freedom for years, and now, for the first time, Sumner’s monothematic mind has locked into answering me with a childish ‘come back here when you figure out what an AS/AD model looks like’ every time I post (I was questioning why Sumner’s AS curve was vertical rather than downwards sloping; btw he’s never answered).

    Seems I might get the coveted MF silence treatment, a sure sign that my arguments have won.

  11. Gravatar of Benjamin Cole Benjamin Cole
    3. July 2016 at 06:55

    Matthew Waters:

    I am not sure I savvy. There is global excess capacity in steel, nearly all commodities, autos, tech gadgets, clothes, even food. Unless OPEC is successful, even oil.

    Do you mean to say some capacity should be shut down? That is possible, especially if central banks continue to suffocate the global economy.

    I would rather we shoot for prosperity and try to use the wonderful capacity that has been built up. This is the era of the supply side! It is huge!

    Services are traded internationally at the click of mouse button. There are more cargo ships, and huge ones, than ever before. Our productive capacity has never been greater.

    On money-financed fiscal programs, I just think, “Why keep your best player on the bench?”

    This is the typical Ben Bernanke-type timidity. Bernanke says MFFP will certainly work, but you gotta save that for when you really need it.

    I would prefer our best player be used constantly.

    Japan is trying negative IOER, QE and fiscal deficits. They just reported deflation again, despite the highest labor markets in 24 years.

    Dudes, time to wear the long pants. Quit tweety-birding around with equations and sissy sermonettes.

    You cannot monetarily suffocate a voting population into liking free enterprise.

    Print money until you get to Full-Tilt Boogie Boom Times in Fat City. Then print some more.

    When we have such “labor shortages” that President Obama is steaming and ironing his own pants, then perhaps then we could consider tighter money.

  12. Gravatar of Major.Freedom Major.Freedom
    3. July 2016 at 07:21


    Sumner only replies when he can refute an argument.

    You can always show you understand the AS/AD curve by retracting your comment that AS must always be a vertical line even in the short run.

  13. Gravatar of Ray Lopez Ray Lopez
    3. July 2016 at 10:40

    @MF – I never made that statement, but now that you mention it, perhaps Sumner is referring to this: “the money supply may be a vertical supply curve, if the central bank of a country chooses to use monetary policy to fix its value regardless of the interest rate; in this case the money supply is totally inelastic.” (Wikipedia).

    I’m not holding my breath for a reply, as Sumner is a slippery fellow.

  14. Gravatar of Major.Freedom Major.Freedom
    3. July 2016 at 10:49


    The AS/AD curve is about demand for goods, not money supply used to demand goods. Also, if the central bank is said to engage in monetary policy, then it is affecting the money supply in order to bring about a particular price inflation or set of interest rates. The money supply would not be fixed. It could be fixed in the short run, if the collapsing of fiduciary credit exactly offsets the expansion of the money supply the Fed brings about, but history has the money supply changing on virtually a daily basis.

    AS is the aggregate supply of goods.
    AD is the aggregate demand for goods.

    These are the components of the “AS/AD curve.”

  15. Gravatar of rayward rayward
    3. July 2016 at 10:56

    Inflation: a general increase in prices. How can there be a “general increase” in prices absent rising wages (in excess of increases in productivity)? Sumner’s way of looking at this comes closer than the rest; after all, rising NGDP is more likely to signal rising wages than the other indicators. I will suggest that what many refer to “inflation” is actually bubbles (an increase in prices that isn’t a general increase). Trying to control bubbles with tools designed to control “inflation” is equivalent to killing a fly with a hammer; it’s likely to do more damage than good. I recall Larry Summers’ Okun Lecture given as the financial crisis was unfolding and his assessment that the Fed did not see “inflation” lurking in the background (because experts like himself had learned how to overcome the Phillips Curve dilemma). Of course, Sumner has made the (correct) observation that monetary policy in 2007-08 was too tight, likely because the Fed, like Larry Summers, could see “inflation” lurking in the background when in fact it wasn’t (bubbles aren’t “inflation”). To be fair to Summers, he has long since acknowledged his error (indirectly anyway by no longer promoting the view expressed in his Okun Lecture).

  16. Gravatar of Anand Anand
    4. July 2016 at 06:05


    Reading Krugman’s post on Autor et. al. (http://krugman.blogs.nytimes.com/2016/07/03/trade-and-jobs-a-note/), I am struck at how some of his criticisms (about going from regional responses to aggregate without considering the macroeconomic response) mirror yours in the post you made here (http://econlog.econlib.org/archives/2016/02/autor_dorn_and.html).

    See the last three paragraphs in particular.

  17. Gravatar of ssumner ssumner
    4. July 2016 at 12:19

    Ray, You said:

    “I was questioning why Sumner’s AS curve was vertical rather than downwards sloping; btw he’s never answered”

    The post in question did not contain any AS/AD diagrams, which showed me that you didn’t know what the AS/AD model is. Now start hitting the books, AS/AD is a model that you need to know!

    Anand, Thanks. I did a post on that last night, at Econlog.

  18. Gravatar of Ray Lopez Ray Lopez
    4. July 2016 at 21:13

    http://www.themoneyillusion.com/?p=31766 is the post in questions

    Sumner, MF–review IS-LM https://en.wikipedia.org/wiki/IS%E2%80%93LM_model) and get back to me when you understand it. It’s conventional to say that “The equilibrium level of national income in the IS-LM diagram is referred to as aggregate demand”

    Sumner’s graph is confusing at best and downright wrong at worst, typical of Sumner’s sloppy thinking.

  19. Gravatar of ssumner ssumner
    5. July 2016 at 08:22

    Ray, So you are saying an IS-LM graph is an AS/AD graph? Thanks for putting a smile on my face.

  20. Gravatar of Ray Lopez Ray Lopez
    5. July 2016 at 09:00

    @sumner – no, I’m saying your graph in the 31766 link is confusing, and not properly explained. Never mind, let’s move on, back to insulting you.

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