Voices from the past

The Fed releases minutes of their meetings with just a few weeks delay.  But the full transcript is kept secret for “an extended period” to insure more candor in the discussions.  Matt Yglesias recently suggested I look at the recently released FOMC transcript from February 2005, which contains an extended discussion of the pros and cons of inflation targeting.  There’s a lot of interesting stuff:

1.  There is pretty general agreement about the Fed’s long term inflation objective.  They’d like to see about 1% actual inflation.  Because they believe the PCE overstates inflation by 0.5% and the CPI overstates inflation by about 1.0%, they’d like to see about 1.5% PCE inflation or 2.0% CPI inflation.  I was quite surprised by the uniformity of views on this issue.  I don’t recall anyone who put forward a different number, just a few who discussed the advantages of ranges (1% to 3%) rather that point targets.

2. The committee does not favor a hard inflation target.  About half the members (led by Bernanke) favor giving the public a specific quasi-official number as a sort of goal, with the understanding that the Fed might have to deviate in the short run due to financial crises and/or supply shocks.  Other readers might disagree with this characterization, as they danced around the issue in a very tentative way, knowing it was actually Congress’s prerogative to set any formal policy goal.  The FOMC was obviously a bit distrustful of having Congress get heavily involved in monetary policy.

3.  I now feel much more confident in asserting that the Fed’s implicit target is 1.5% PCE and 2.0% CPI inflation.  Period.

4.  They also clearly indicated that a higher than 2% inflation rate might be appropriate under one of two conditions:

a.  Financial crisis

b.  Adverse supply shock

And they clearly acted on that belief in 2007 and 2008 when they cut the Fed funds rate during the sub-prime crisis, despite above 2% inflation.  However, I think they may have tragically misunderstood the implications of their supply shock arguments, and that’s the issue I’d like to focus on.  Consider the following quotation from Cathy Minehan.

So my policy preference for a given level or path of inflation would not be identical all the time. It would depend on what is happening in the real economy, just as in the first half of 2004 we tolerated rather rapid price growth on the basis of our calculation of the degree of excess capacity in the real economy and the temporary nature of the energy price increases. I know that over the long run there’s no tradeoff between growth and inflation and that price stability, however defined, is the best contribution monetary policy can make to economic prospects. But in the short run, when supply shocks can dominate, there can be  tradeoffs.

She is saying that if unemployment is sort of high, say 7%, and inflation was 3% due to energy price increases, you would not try to immediately bring inflation down to 2% if it meant pushing unemployment up to 9%.  And I am pretty sure that everyone at the Fed agrees with that.  However the inescapable implication of the argument is that if you have 9% unemployment and 2% inflation, you’d be better off pushing inflation up to 3% if it would reduce unemployment down to 7%.  The argument is completely symmetrical.

I saw no signs that the Fed understood this implication in 2005, and I still don’t.  Indeed when Brad DeLong asked Bernanke in 2009 why they don’t raise their inflation target to 3% to boost growth, Bernanke said it would be a very bad idea.

The problem here is that either there is a dual mandate, or there isn’t.  If there is, then the Fed would want to allow slightly higher than 2% inflation during adverse supply shocks (and vice versa.)  And I think they do.  If not, they should aim for 2% inflation come hell or high water.  And that’s clearly not what they do.  But this dual mandate idea also implies that if unemployment is extremely high due to deficient demand, the Fed should try to aim for above 2% inflation to try to bring it down.  Yet the Fed seems to vehemently deny any intention of aiming for above 2% inflation during a period of 9.5% unemployment.  Why?  What sort of social welfare function allows for accommodating supply shocks (or financial crises) but doesn’t allow for an aggressive move against deficient demand?

Of course all this confusion would be eliminated with . . . NGDP targeting.

Fun quotations:

[William Poole] The one other case is not a U.S. case but Japan. I think the Japanese have also suffered from not being very clear that they do not want deflation, particularly as the situation developed in the early 1990s. The markets were left quite at sea in trying to figure out where Japanese monetary policy was going to go.

CHAIRMAN GREENSPAN. I think they still are.

MR. POOLE. Yes, they probably still are.

And this probably describes September 2008:

A third potential cost could arise if your credibility were seen to be diminished when inflation differed from the stated objective. Finally, a commitment to an explicit price objective could constrain future actions of the FOMC in an unhelpful manner. For example, the Committee might feel inhibited in responding as aggressively as it would like to a financial crisis if inflation were already to the high side of the Committee’s objective. [Wilcox, et al.]

I don’t quite agree with this, but it is interesting:

[Gramlich] There’s an old experiment that I learned about in graduate school from Richard Ruggles, who used to be a professor at Yale: Offer somebody $10,000 and the choice of ordering from a catalog of all goods and services made this year or five years ago, and take a poll on which option they vote for. Try it. You all give talks to Chambers of Commerce and so forth. I’vebeen doing it for years, and people will consistently vote for the current menu. Obviously, this experiment has to be done at a much higher level of scientific rigor. But I think in the utility sense, even core PCE rates as high as 3 percent may be more or less consistent with price stability, given the great difficulty we have in dealing with technological change in price indexes.

The problem is that consumption is a social activity.  Do they mean you have the old catalogue and everyone else has the new one, or everyone has the old catalogue and their current nominal income.

And I’m guessing that someone like Bob Murphy won’t agree with the claim by Greenspan that they “lucked out” after easy money was pursued in 2004 despite the fact that the inflation target called for tightening:

Take the spring of 2004, when we were sitting there with a significant acceleration in core inflation. With a targeted range for inflation, conceivably we would have breached one of the limits of the target range. And the question would have automatically arisen, “Well, what are we going to do about this?” My answer would have been””and indeed at the time was”””nothing.” The reason was that I viewed the rise in prices as wholly the consequence of a rise in profit margins. But that rise in profit margins was sufficiently quick to result in a projection of core final goods prices that would be above any reasonable target we’ve been discussing today.

The point is this: That was a particular case where we knew that unit costs were not moving and that the rise in inflation was wholly a mechanical result of a one-shot event, which couldn’t continue unless unit costs started to accelerate. We lucked out.

I think people overstate the role of easy money in the sub-prime fiasco, but I included this quotation because I know that most people disagree with me.

On other topics, Tyler Cowen recently made this observation in response to data showing brisk growth in industrial output:

Yet the labor market is still “eh.”  Here is more, but again note it is wrong to reject the AD factor altogether, though it seems to be becoming less relevant over time.  Arguably AD and AS are interacting in unusual and presumably deleterious ways.

I have read too many blog posts attacking a caricatured version of either RBC theory or a narrowly defined notion of “structural unemployment” which requires excess demand for labor in significant parts of the economy.  As Arnold Kling points out, the labor market shock can be asymmetric in its effects.

From a different direction, here is Scott Sumner criticizing the recalculation argument.  I read Scott as establishing the conclusion that both AD and AS must be at work.

I don’t quite agree with the first part, where Tyler discusses the weak labor market.  I’ll simply link to my previous post, which explains why.  I do agree that our problems are partly real/structural/supply-side.  But I still think it is mostly demand-side, and that demand stimulus would even indirectly improve the supply-side (i.e., UI would be reduced below 99 weeks more quickly, which would further normalize the labor market.)

I was flabbergasted to see my first positive link from Paul Krugman.  Of course our views on the need for demand stimulus are similar, but we always seem to tangle on the nuances of some issue.  Indeed perhaps 1.5 positive cites, as this Krugman post is probably referring to me and Beckworth.  I recently published something in the National Review, and Beckworth published in the Wall StreetJournal.

Now I have a sudden fear I will lose all my right-wing friends.  I can just imagine what Bob Murphy will do with this.  And of course I’m way too right-wing to ever be embraced by the left.  I’ll be in limbo, along with Bartlett, Frum, Lindsey, Wilkinson, etc.

Oh well, que sera, sera.

PS.  My consolation is that if Milton Friedman were alive, he’d be in the same awkward position.

PPS:  I got a Business Week mention.



19 Responses to “Voices from the past”

  1. Gravatar of Greg Ransom Greg Ransom
    15. January 2011 at 12:56

    You’ll lose your libertarian friends if you keep calling them “right wing”.

  2. Gravatar of scott sumner scott sumner
    15. January 2011 at 13:02

    Greg, I mean that in an affectionate way.

  3. Gravatar of Greg Ransom Greg Ransom
    15. January 2011 at 13:03

    “Right wing” is the term Soviets and Marxists invented to distinguish themselves from Hitler and Trotsky and the Italian fascists. It is a term the NY Times uses to identify racists and anti-semites and abortion doctor killers.

    Classic liberals / libertarians are not “right wing”, unless your aim it to smear people.

    The first duty of classical liberals is to take back the language, own it, use it and not self-smear tgemselves with the language of the leftists.

  4. Gravatar of Greg Ransom Greg Ransom
    15. January 2011 at 13:06

    The NY Times and the hosts of MSMBC aren’t being affectionate when they identify someone as right wing.

    Their are identifying you as some who could kill a congresswoman out of hate — and thry are kidding around in thinking so.

  5. Gravatar of Greg Ransom Greg Ransom
    15. January 2011 at 13:12

    If Hayek and Friedman are on your side, I don’t think you need to worry about what a a beclowned little troll like Paul Krugman has to say.

  6. Gravatar of Morgan Warstler Morgan Warstler
    15. January 2011 at 13:12

    Scott the post from Matty is highly annoying. Hoenig was right, and you have admitted it here in the past month, money was too loose in 2005. I believe you said 2004-06.

    That’s the message! And if you can’t do the post where you say, “The Fed should have been raising rates,” then you lose all ability to scream from loose money now.

    Even now as you call for more easing, you should be talking about WHEN the punch bowl gets pulled away. The more forceful your promise, the more people will trust you now.

    Also, why aren’t you more aggressive saying to promote more monetary stimulus, we make real cuts in fiscal spending NAMELY public employee pensions.

    After all, the argument is completely symmetrical!

    You argue the Fed goes flaccid on QE when there is fiscal spending, so the more fiscal cutting you champion, the more QE you can expect. You should be cheering to end sticky wages at every corner… another moral obligation you take on, when you argue they are real, you have to FIGHT THEM.

  7. Gravatar of scott sumner scott sumner
    15. January 2011 at 13:30

    Greg, Right wingers like me call Pol Pot and Stalin “left wing.” So why isn’t a liberal insulted by “left wing.?”

    Morgan, I said it was slightly too easy, but not a major cause of the housing bubble.

  8. Gravatar of Greg Ransom Greg Ransom
    15. January 2011 at 14:15

    “Greg, Right wingers like me call Pol Pot and Stalin “left wing.” So why isn’t a liberal insulted by “left wing.?””

    That’s for leftists to explain.

    It’s always shocking to see how powerful anti-anti-communist / antir-classical liberal intellectual current in America has been — and something decisive happened in the 1965-1985 period.

    Perhaps the Marxist / Socialist / Democrat German Social Democrats and the Norman Thomas movement perhaps gives left wingers a strong sense that one can be left wing without being a Soviet or Chinese communist.

    But lets also not forget this. Truman Democrats fought against the left wingers for control of the Democrat party and the unions — and then something changed in the 1965-1985 period. The New Left and those more comfortable with the left than with conservatives took over the universities and the Democrat party — and in the 1974-1978 period the world gained clarity about the significance of private property, the price system and the rule of law. A great divide emerged, one larger than that between John Kennedy and Richard Nixon.

    Those on the left perhaps are comfortable with the language of the left because they are on the left, and they comfortable with being honest about that — this comfort with honesty about ones politics isn’t always the case on the left.

    Stanley Kurtz documents how a powerful group of American socialsits have hidden consciously behind other labels since the 1970s, a group which at one time had Obama amoung its active participants.

  9. Gravatar of Tom P Tom P
    15. January 2011 at 14:22

    Wow. Some intense comments above.

    Just want to congratulate Scott on an excellent week of posts! In particular I’m glad you’ve responded to Tyler’s zero marginal product worker idea.

  10. Gravatar of Jason Jason
    15. January 2011 at 15:40

    Very interesting. And I second Tom P.

  11. Gravatar of Benjamin Cole Benjamin Cole
    15. January 2011 at 16:13

    I think it is time for a long vacation when I find a five-year-old FOMC transcript to be fascinating. But it is.

    I sense there is migration to NGDP targeting, or at least honking the horns about higher inflation. Poole’s comment about the BoJ not letting Japan know it would fight deflation is telling.

    The economy is mending, and so Bernanke is being cautious, not wanting anyone ever to hint he was loose in some way (central bankers guard their reputations like chaste women in small town Victorian England). Bernanke also has to puzzle over the nutcase Ron Paul, who will have oversight in 2011 (is this one of the worst ideas you have ever heard?).

    But we may get to NGDP targeting in the next couple of years. That and QE may become permanent features of a new monetary lexicon.

    The world may generate “too much” capital in coming years, and new methods will have to be developed to handle this problem.

  12. Gravatar of honeyoak honeyoak
    16. January 2011 at 09:03

    Scott, as to why the fed is worried about creating inflation with a high unemployment rate I think that there is a genuine worry that an aggressive QE will spook T-bill investors causing the government deficit financing (from china and the like) to become unsustainable. the US is not a small open economy making the markets sensitive to US debt issuance. If you watch this AEI event featuring meltzer and volcker, I was surprised to find out how prominent the actions of the treasury are on the FOMC’s decisions. I am not saying this is the only reason for their hesitancy, but it seems like a plausible one.


  13. Gravatar of Jeff Jeff
    16. January 2011 at 09:38

    I agree with Greg. Friedman and Hayek both considered themselves classical liberals, not conservatives.

    I was flabbergasted to see Krugman admit that Friedman’s criticism of the Depression-era Fed was that it allowed M2 to fall. Krugman has posted a plot of the monetary base during the late 20’s and 30’s numerous times and claimed that the fact that it rose through that period proves, contra Friedman, that monetary policy is not effective in a liquidity trap. Evidently he is sure that his readers are too stupid to notice the contradiction.

  14. Gravatar of Morgan Warstler Morgan Warstler
    16. January 2011 at 11:48

    honeyoak, I think that’s the flip side of the same thing I keep asking Scott…

    Assumption: As Scott says the Fed neutralized fiscal by not doing more monetary because of fiscal. They are reactive.

    Assumption: With a hard fast 2% CPI target, then the MORE deflationary forces brought to bear with fiscal (cutting spending), the MORE QE we’ll get from the Fed.

    Assumption: Scott is not on the Fed, he’s a right wing liberal…. so he doesn’t have to be non-partisan.

    So then, WHY doesn’t Scott SCREAM for dramatic cuts to current fiscal spending AS THE DRIVER to getting more QE.

    Posit: If the multiplier is lower on fiscal, Scott should be taking a flame thrower to public employee unions DAILY.

    1. It is HUGLEY politically opportune (large majority of likely voters support it) and thus realistic.

    2. It gives MEANINGFUL assurance to the bond market about future risk.

    3. Even though wages are sticky, if you want to build monetary policy on this, you are morally obligated to try and kick the legs out from under sticky wages at every corner.


    I’m interested in everyone else’s take here too, including all the liberals…

    WHY do you think Scott isn’t more aggressive going after making major productivity gains int he public sector, so he get MORE QE?

  15. Gravatar of Bob Murphy Bob Murphy
    16. January 2011 at 11:48

    Scott, I think you and I have to check in to a clinic somewhere, since we each obsess about Krugman so much. You’re right, I did indeed have fun with his latest (before I saw your post here). I can’t decide which is worse: The fact that you narcissistically obsess over someone who occasionally mentions you, or the face that I voyeuristically obsess over someone who occasionally mentions you.

    Now back to being serious, I think Krugman is embracing you (and Beckworth etc.) because Ron Paul and the rest of “the crazies” are taking over. In his mind, you are Stalin, Krugman’s FDR, and I’m Hitler.

  16. Gravatar of W. Peden W. Peden
    16. January 2011 at 12:50


    Either that or he’s discovered the difference between M2 and the monetary base…

    … Yeah, it’s probably that.

  17. Gravatar of mbk mbk
    16. January 2011 at 16:33

    Scott, just a tidbit outside the heaviness of the main flow of argument:

    “The problem is that consumption is a social activity.”

    Yes. This is so important and yet I am pretty sure most people do not understand that quote, or else there would be fewer hydraulic engineering type economics/econometrics. Intuition goes against it, it’s easy to mistake consumption for the satisfaction of material needs alone. Anyhow, this is why you are so interesting to read – your arguments are always multi layered and diverse.

  18. Gravatar of scott sumner scott sumner
    16. January 2011 at 18:30

    Greg, You should be debating Patrick on a earlier post. I was making a similar argument (as you) about anti-anti-communism.

    Thanks Tom and Jason. I found one ZMP worker, the punter for the Green Bay Packers.

    Benjamin, I hope you are right. I think the BOE’s interest is significant, as England has usually been ahead of the curve on monetary policy.

    honeyoak, I’m confused, QE makes the government deficit smaller. Indeed the recent fall in NGDP made the deficit much worse. If NGDP were 10% higher we’d have a far smaller budget deficit.

    Jeff, I don’t consider myself conservative, I am a right wing liberal. Krugman argues the Fed was not capable of raising M2 during the Great Depression, because banks would just hoard reserves. I don’t agree, but he does distinguish between the base and M2 (sometimes).

    Morgan, You said;

    “So then, WHY doesn’t Scott SCREAM for dramatic cuts to current fiscal spending AS THE DRIVER to getting more QE.”

    I’ve advocated the Singapore fiscal regime, which spends far less as a share of GDP than our government.

    Bob, Are Hitler and Stalin the only two choices? Can’t we be someone a bit less awful, like Franco or Castro?

    mbk, Yeah, I’m glad you picked that up. Economists assume that someone today who had the consumption bundle of a typical middle class person in 1911, would be just as happy as that person. In truth, they’d feel very poor, even if you added 2011 health care to the mix. All their friends would have plasma TVs, and they wouldn’t even have a radio.

  19. Gravatar of Morgan Warstler Morgan Warstler
    16. January 2011 at 20:12

    “I’ve advocated the Singapore fiscal regime, which spends far less as a share of GDP than our government.”

    Oh yes, that’s SURE to ruin the day of Matty, Reich, and DeKrugman.

    When they want hate you, you’re being honest. When they have to stop hating you and bend, then you really win.

    You can’t sneak it in their backdoor. In every situation someone buys and someone sells, you have to make them let go of big government as the way to drag the bottom up… otherwise, you are just a another kind of tax, when they can’t get it directly.

    Your ideas = CUT GVT SPENDING.

    The Fed will give you more QE, now we know it, if you cheer aggressive deflationary fiscal spending cuts.

    And the best you can do is, “I have advocated Singapore?”

    Boy you really want that QE.

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