What would Narayana Kocherlakota have done in 1933?

Here’s Narayana Kocherlakota:

Federal Reserve Bank of Minneapolis President Narayana Kocherlakota said the central bank has put its credibility at risk by easing during a year in which inflation rose and unemployment fell.

.   .   .

“As the economy recovers, the FOMC should respond by reducing the level of monetary accommodation,” Kocherlakota said.

“The FOMC should only increase accommodation if the economy’s performance, relative to the dual mandate, actually worsens over time,” he said, referring to the central bank’s goals of maintaining price stability and ensuring full employment.

Between March and December 1933 the unemployment rate probably fell a bit, say from 25% to 23%.  And inflation rose.  So are we to assume that Kocherlakota would have voted to tighten monetary policy at that time?

We can take some comfort from the fact that the Fed is currently headed by a Great Depression scholar.  Surely he wouldn’t recommend tightening monetary policy just because inflation rose at bit and the unemployment rate dipped a bit.  After all, the economy is still severely depressed and most indicators point to low inflation ahead.  See what you make of this statement by Ben Bernanke:

The Fed’s chairman, Ben S. Bernanke, has said since the decision was announced that the central bank is willing to act again if necessary, but also that there would be a high bar. In particular, he has said that the Fed was most likely to act if the pace of inflation abated to the point where there was a risk that prices and wages might begin to decline. Such a trend, known as deflation, can cause buyers to delay purchases, derailing the economy.

Didn’t the decision to end QE2 effectively tighten policy?

I’m sure many of you are thinking that I just don’t get it.  The Fed knows what it is doing; they simply have a different objective function from us market monetarists.  OK, let’s see if they know what they are doing.  Do they rely on voodoo VAR models, or market forecasts of inflation?

The minutes, which are normally released three weeks after a policy decision, made clear that the Fed had not changed its view that the pace of inflation was likely to remain at roughly 2 percent a year, the rate that the Fed considers most healthy.

Yet the TIPS spreads show less than 2% inflation over the next 5 years, and the Cleveland Fed says the correctly measured expected inflation rate is lower still.

“But what makes you think markets can forecast better than the Fed?”  How about this:

The internal divisions were partly the product of a lack of clarity about the health of the economy. In its predictions since the end of the recession, the Fed has repeatedly overestimated the pace of economic growth, and the minutes report that the board does not understand why it has been wrong.

“It was again noted that the cyclical impetus to economic expansion appeared to be weaker than in past recoveries, but that the reasons for the weakness were unclear,” the minutes said.

The Fed noted that labor market conditions in particular had been disappointing, with companies adding fewer workers than expected. It also noted that both consumers and businesses remained surprisingly pessimistic.

When the markets expect your policy to fail, it might succeed.  But I wouldn’t count on it.

Actually, the Fed has no reason to believe it has provided any “accommodation” at all.  None.  Let’s review what they have done:

1.  Cut rates to near zero, just like the Herbert Hoover Fed and the Bank of Japan did.  A situation Milton Friedman correctly called a sign that money has been too tight.

2.  Injected lots of reserves, but then neutralized their effect by paying IOR at a rate exceeding T-bill yields.  High-powered money is high powered if and only if it earns an interest rate below that of bonds.

3.  Promised to keep interest rates at Herbert Hoover/BOJ levels for years to come.

4.  Operation Twist; a policy that was widely viewed by monetary economists to be a pathetic failure when it was tried in the early 1960s.

Have I missed anything?



20 Responses to “What would Narayana Kocherlakota have done in 1933?”

  1. Gravatar of Nick Rowe Nick Rowe
    13. October 2011 at 14:33

    If your car is gaining speed, you ought to ease your foot off the gas pedal. Except when you are already going too slow to begin with. Levels, and rates of change.

  2. Gravatar of Peter Peter
    13. October 2011 at 14:37

    As Svensson recently wrote: levels are more important than growth (or something similar).

  3. Gravatar of Morgan Warstler Morgan Warstler
    13. October 2011 at 14:43

    Yes, they are neutralizing Obamacare, and making sure the Fiscal side isn’t being papered over.

    Something dawned on me, maybe it is because you have Romneycare, that you are gladdened by the rest of the states having drink that poison too???

    Maybe you don’t fret it like normal real people (businessmen) do.

    Somewhere in there Scott lurks a basic human bias that keeps you from seeing the biggest problem we face as the biggest problem we face.

    You don’t worry about public employees being paid too much, and that is the BIGGEST problem we face. And you don’t worry about SMBs being treated like gods.

    To you these are just possible economic paths, but to normal people these are REQUIREMENTS to save what is essential about America.

    Undoing this stuff just matters at a basic level.

  4. Gravatar of StatsGuy StatsGuy
    13. October 2011 at 15:53

    “You don’t worry about public employees being paid too much, and that is the BIGGEST problem we face”

    Really? Of all the problems the world faces, that’s the worst? Not public debt incurred at the peak of the Boomer earning years, not past pay scales for the (diminishing number of) public employees, not the retirement obligations of past employees that were not pre-funded, not peak commodities, not hegemonic transition, not climate change, not aging of the population, not war or caring for wounded or the fact that the 85% of the military that never sees combat receives the same TriCare benefits as combat veterans… It’s public employee wages?

    That’s cute. BTW, why do you hate big business and put small business ahead of large business? Big business proportionately exports more, and creates a lot of new technology and infrastructure. Productivity levels are typically higher for big business as well (which is one of the reasons small businesses generate more hiring). What is your rationale for favoring one group of businesses over another?

  5. Gravatar of Mitt Mitt
    13. October 2011 at 16:25

    “What is your rationale for favoring one group of businesses over another?”

    His rationale is the same as all leftists: class warfare.

  6. Gravatar of ssumner ssumner
    13. October 2011 at 17:04

    Nick and Peter, That’s right, especially if the car gains less speed than you’d hoped for.

  7. Gravatar of Morgan Warstler Morgan Warstler
    13. October 2011 at 17:39

    Statsguy, I’m giving you (again) real meaty weighty answers and you will not pay attention, they will flit past you, but the logic runs my way.

    1. Public employees this year are being overpaid $500B using 1998 as the baseline.
    a) counting inflation, they should be getting $1.2T this year, not $1.7T.
    b) any raises they received since 1998, should have come through productivity gains – firing Bob.

    A: Add up the overpay since 1998 plus interest and we’re talking $7T wasted since 1998. That’s a national debt lower by almost half, that’s a stronger economy today – to achieve it, the government would have had to AUTOMATE to GOV2.0, and we’d have an even stronger foothold globally in info.tech.

    There have been no improvement in public service since 1998, it’s just gotten worse.

    Your brain keeps you from properly weighting the negative impact of this…. so maybe this will get through:

    KEYNESIAN ECONOMICS says public employees can NEVER have boom times, precisely so that when thing go to shit, the costs are lower, and they don’t need to be fired.

    2. You are wrong about the Fortune 1000 and SMBs. Logic and college football prove me right.

    New job growth comes from newcos that spin up out of the 2% of SMBs that go ganbusters.

    High school football is 100% of SMBs.
    College ball is 2% of SMBs that make 50% of SMB revenue.

    Out of college ball the all stars that go big – that’s where the jobs come from.

    So my plan is to treat college players like big men on campus, treat them even better spiritually, favored nation status over even than the guys in the pros already.

    The main reason is that if you look at “serial entrepreneurs” they are the calls of investor that lives int he 2%.

    So even when they have an SMB that grew a bit, and faded, didn’t burst out – WE WANT THEM TO DO IT AGAIN.

    Right now the tax law PUSHES them to stick with the old company – if they keep their profits inside it, they don’t declare income, so they open another yogurt shop, whatever, instead of throwing on some new completely different thing.

    Stats, since you like numbers – what I’m after is increased turnover in JOLTS data.

    Whenever we get up over 5M+ turns monthly we see positive growth in jobs. When it is nearer to 4M we lose jobs.

    I want to structure our economy FOR creative destruction, and since Corporatists and Big Government go hand in fist…

    We have to actually CODIFY favoritism of the serial entreprenuers, we want to make it so favorable to live in the 2% of SMBs, that the very best and brightest ALL go do it.

    Now I have given you two very strong rational answers to your questions, please extend your knowledge of my arguments, so the next time you ask questions we are father along.

  8. Gravatar of Mark A. Sadowski Mark A. Sadowski
    13. October 2011 at 20:49

    Scott wrote:
    “Have I missed anything?”

    Nothing of course. Excellent. Well done.

    P.S. I would appreciate it if you would address Krugman’s response to Konczal’s post where he claims

    “I would submit, by the way, that the quasi-monetarists “” QMs? “” have actually backed up quite a bit on their claims. They used to say that the Fed can easily and simply achieve whatever nominal GDP it wants. Now they’re more or less conceding that the Fed has relatively little direct traction on the economy, but can nonetheless achieve great things by changing expectations.”


    Did I miss something? Or did us “queasy-monetarists” (as he defames us) back-pedal on anything?

    I don’t remember backing up at all. In fact I say now, as always: damn the torpedos, full speed ahead!

  9. Gravatar of Mark A. Sadowski Mark A. Sadowski
    13. October 2011 at 21:14

    Film quote. From “In Harms Way.”:


    So on and so forth. We can do it.

  10. Gravatar of Morgan Warstler Morgan Warstler
    13. October 2011 at 21:56

    Mark, Scott read it, but he chose, as he does, not to grab the bat out of DeKrugman’s hand and beat him like a ginger step-child.

    that’s part of the problem.

    Ask yourselves: how many nice things would Friedman (WWMS!?!) have to say about a sniveling DeKrugman?


  11. Gravatar of Mark A. Sadowski Mark A. Sadowski
    13. October 2011 at 22:20

    Unlike Krugman, DeLong, Friedman or Sumner I would waste no time in smacking the heck out of you and you know it. I do it every day and I have no regrets.

  12. Gravatar of marcus nunes marcus nunes
    14. October 2011 at 04:37

    Kocherlakota is the sort of “poster economist” of the present age. A “math wizard” but with no enonomic intuition or even understanding!

  13. Gravatar of Scott Sumner Scott Sumner
    15. October 2011 at 08:11

    Mark, I did it a few posts back.

    Marcus, It sure seems like modern conservatives haven’t studied Milton Friedman.

  14. Gravatar of Greg Ransom Greg Ransom
    16. October 2011 at 16:40

    “monetary stimulus”

    Your arguments are continually undermined by your pathological use of language …

    If the argument is a monetary disequilibrium argument, why mislead everyone and undermine the logic of your argument with the unhelpful and misleading word “stimulus”?

  15. Gravatar of ssumner ssumner
    17. October 2011 at 06:54

    I answered this elsewhere.

  16. Gravatar of Richard Fischer Chernyshevsky ; Kocherlakota, the Scrivener | Rortybomb Richard Fischer Chernyshevsky ; Kocherlakota, the Scrivener | Rortybomb
    19. October 2011 at 08:49

    […] doesn’t make any sense.  First of all, as Scott Sumners points out, an historical comparison would be Kocherlakota wanting to tighten monetary policy in 1933. […]

  17. Gravatar of John B. Chilton John B. Chilton
    19. October 2011 at 12:27

    Scott, Just watched the video; very helpful to this neophite. I find your analysis of the Fed’s mistakes of tightening money compelling. I’m sure you’ve answered it until your face has turned blue, but following your analogy of setting monetary policy like you would set a course for a sea port, how do you make headway if you are becalmed? How can the Fed move NGDP in the current environment? Does it require that the market set its expectations on what the Fed says it will do, even if the Fed won’t achieve it’s goal if the market doesn’t believe.

  18. Gravatar of Ken Houghton Ken Houghton
    20. October 2011 at 07:33

    You didn’t miss anything notable, but

    “2. Injected lots of reserves, but then neutralized their effect by paying IOR at a rate exceeding T-bill yields.”

    is rather optimistic. Neutralized would imply no harm.

    I can’t imagine a reasonable economic model for a market economy in which you **** with the risk-free rate and no harm is done.

  19. Gravatar of Scott Sumner Scott Sumner
    29. October 2011 at 05:57

    John, A better analogy is flowing down a river, and trying to avoid each bank. The “becalmed” is actually one of the river banks you try to avoid. The Fed sets a target and buys bonds until the market believes the target.

  20. Gravatar of Scott Sumner Scott Sumner
    29. October 2011 at 05:57

    Ken, I agree that IOR does harm.

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