What I said on August 21st

See how this looks today:

So both Hamilton and Greg Mankiw have suggested a price level target with a 2% trend growth rate.  These are both highly respected moderates who don’t shoot from the hip like I do.  They both praise Bernanke.  I see this as a real test for Bernanke and the FOMC.  If the Fed won’t even do this little amount . . .   Something that would not require tearing up the (implicit) 2% inflation target and replacing with another number.  Something that would anchor the price level and remove any lingering fears of high inflation.  A policy that could be defended even if the Fed didn’t give a damn about unemployment at all, if the Fed lacked a dual mandate.  If they won’t even do that much, then the Fed will have abdicated all responsibility.

Even the Hamilton/Mankiw proposal would represent failure, relative to what the Fed would be expected to do if rates weren’t stuck at zero.  But at least it would be something (unlike Operation Twist, which seems like nothing to me.)

The TIPS markets show very clearly that investors have given up on the Fed.  There will be no level targeting (of prices or NGDP.)



8 Responses to “What I said on August 21st”

  1. Gravatar of Ram Ram
    22. September 2011 at 07:52

    The 10-Year TIPS spread fell 10 basis points yesterday following the Fed’s statement, and is today down another 10 basis points from there. If this trend continues, it won’t be long before inflation expectations get to where they were when the Fed decided to embark on QE2. Even if QE2 was grossly inadequate (which it was), how is the Fed going to rationalize doing even less when the very thing it was worried about then, deflationary expectations, come back on the radar? At this point, one need not adhere to any particular model of the crisis to conclude that the Fed is not making decisions on the basis of economic considerations. Perhaps when historians of US economic policy look back on the Perry threat, the chorus of Republican presidential candidates promising to fire Bernanke, and the politically threatening letter from the Republican leadership in congress, they will mark this period as the end of the period of central bank independence in the United States.

  2. Gravatar of MikeDC MikeDC
    22. September 2011 at 07:54

    I made this basic comment in the Taylor thread, but it seems applicable here.

    Why has the Fed gone cuckoo over interest rates? I mean, they’re doing crazy stuff to further lower them!

    Because the basic model is that lower interest rates leads to more borrowing which leads to more employment.

    They are focused on employment! To the detriment of hitting their price stability target.

    Because they’re totally locked in on the wrong concept to the exclusion of all else. We’re all taught (and many of us hae taught)in Econ 101 that lower rates lead to more borrowing which tends to lead to more employment. Even most non-economists understand this.

    In fact, they understand it too well, and are being drawn to low rates like moths to a flame.

    Why Bernanke and co don’t understand low rates aren’t the solution to this kind of problem, I don’t understand, but I do understand the situation when I view it from that perspective.

  3. Gravatar of David Pearson David Pearson
    22. September 2011 at 08:01

    The Fed put seems to always have a strike price significantly below where markets believed it to be. When markets discover this, they trade back down to that strike, and the Fed massively intervenes. Rinse, repeat.

    Is the problem that the Fed is not managing market expectations well, or that there is the expectation of a put to begin with?

    Here’s a hypothesis: given any free Fed put (including an NGDP target), actors will maximize the value of that put by employing the maximum leverage/minimum liquidity possible. That is why we constantly land back in the soup of financial crisis.

  4. Gravatar of foosion foosion
    22. September 2011 at 08:04

    >>The TIPS markets show very clearly that investors have given up on the Fed.>>

    Investors are not happy.

    Real rates are 0% 10 year and 0.87% 30 year (and negative shorter), which is really bad if not worse.

    The nominal-TIPS spread is 1.77 at 10 years and 2.01 at 30 years, which is close to 2%, the Fed’s supposed inflation target.

  5. Gravatar of Full Employment Hawk Full Employment Hawk
    22. September 2011 at 08:25

    ” Greg Mankiwhave suggested a price level target with a 2% trend growth rate. These are both highly respected moderates”

    So when is Mankiw going to criticise Romney for arguing that the Fed should not do anything?

  6. Gravatar of James in london James in london
    22. September 2011 at 10:01

    Isn’t it also that the Fed is targetting 30 year interest rates to bring down mortgage rates, massively increase refis, and so help consumers in a fiscally neutral way? Isn’t this what Obama wants? And Bernanke is trying to provide? Not saying I agree with it as a policy, but am trying to see it from Bernanke/Obama’s viewpoint.

  7. Gravatar of Scott Sumner Scott Sumner
    22. September 2011 at 15:58

    Ram, Very good observations. But the weird thing is that while plus 2% price level targeting (preferably core) is far from adequate, it is both much more than we currently have, and much less controversial in the eyes of many hard money types like Taylor and the writers at the WSJ. It’s an explicit price target.

    MikeDC, I agree.

    David, Yes, why can’t they see that in this horrible situation 2% inflation should be a floor, not a ceiling.

    foosion, The 5 year is even lower, and the Cleveland Fed said there are biases so the actual expected inflation is still lower. With 9% unemployment they shouldn’t be undershooting inflation targets. That’s nuts. It’s tighter policy than a mandate that ignores jobs completely.

    FEH, Not as long as he’s Romney’s adviser.

    James, Maybe, But if so Obama is mistaken, as I’m sure he didn’t want the market reaction.

  8. Gravatar of Full Employment Hawk Full Employment Hawk
    22. September 2011 at 21:36

    “FEH, Not as long as he’s Romney’s adviser.”

    I was being sarcastic.

Leave a Reply