Brad DeLong's Grasping Reality...

You Probably Want to Be Over at EQUITABLOG

Equitablog | Missouri State of Mind | "Long Form" | Highlights | WWII Liveblog | Proj Synd | Berk Blog | Across the Wide Missouri | Smartphones | Scratch |
September 25, 2014
Over at Equitable Growth: What Should Monetary Policy Be?: Thursday Focus for September 25, 2014
Over at Equitable Growth: Chicago Federal Reserve Bank President Charles Evans's position seems to me to be the position that ought to be the center of gravity of the Federal Open Market Committee's
thoughts right now, with wings on all sides of it taking different views as part of a diversified intellectual portfolio. Charles Evans:
Charles Evans: Patience Is a Virtue When Normalizing Monetary Policy: "At the end of the second quarter of 2014...
...the labor force participation rate was between 1/2 and 1-1/4 percentage points below trend... as much as 3/4 of a percentage point below predictions based on its historical relationship with the
unemployment rate.... Virtually all the gap during this cycle has been due to withdrawal from the labor market of workers without a college degree.... If skills mismatch were an ongoing problem, wed
expect to see wages rising for those with the skills in demand.... Pools of potential workers other than the short-term unemployed, notably the medium-term unemployed and the involuntary part-time
work force, substantially influence wage growth at the state or metropolitan statistical area level.... Current circumstances and a weighing of alternative risks mean that a balanced policy approach calls
for being patient in reducing accommodation.... The biggest risk we face today is prematurely engineering restrictive monetary conditions.... If we were to... reduce monetary accommodation too soon,
we could find ourselves in the very uncomfortable position of falling back into the ZLB environment.... There are great risks to premature liftoff.... And the costs of being mired in the zero lower bound
are simply very large...
Yet Evans is out there on his own--with perhaps Narayana Kocherlakota beside him.[[1]][3] READ MOAR
[3]: http://www.federalreserve.gov/monetarypolicy/files/fomcprojtabl20140917.pdf (Percent Economic Projections of Federal Reserve Board Members and Federal Reserve Bank Presidents, September
2014: Advance release of table 1 of the Summary of Economic Projections to be released with the FOMC minutes)
As I see it:
1. The past decade has demonstrated that to properly reduce the risks of hitting the zero nominal lower bound on safe short-term interest rates, we need not a 5%/year but at least a 6.5%/year business-
cycle peak safe short nominal rate.2 With a 3%/year short-term peak real natural interest rate, we need not a 2%/year but a 3.5%/year inflation target instead.
2. It is likely that the safe natural real rate of interest has fallen by 1%-point/year. That means that a healthy economy properly distant from the ZLB requires not a 3.5%/year but a 4.5%/year inflation
target.
3. It is very important when the economy hits the zero lower bound on nominal interest rates that expectations be that the time spent at the ZLB will be short. To build those expectations, it is important
that when the economy emerges from the ZLB it undergo a period in which the long-run inflation target is overshot.
4. The likelihood is that downward movements in labor force participation that are cementing into structural impediments to employment can be reversed if high demand pulls workers back into the labor
force before the cement has set, but only with difficulty otherwise. The benefit-cost analysis thus calls for an additional inflation overshoot in order to satisfy the Federal Reserve's dual mandate.
5. If the Federal Reserve aims at a 2%/year inflation target and fails to raise interest rates sufficiently early, it may wind up with 4%/year inflation and have to raise short-term real interest rates to
6%/year--a nominal interest rate of 10%/year--to return the economy to its inflation target. If the Federal Reserve prematurely raises interest rates, it may wind up with 0%/year inflation and wish to
lower short-term real interest rates to -2%/year to return the economy to its inflation rate. With inflation at 0%/year, it cannot do that. Thus the risks are asymmetric: raising interest rates later than
optimal under perfect foresight carries much lower risks than does raising interest rates earlier than optimal.
6. Since 1979 the Federal Reserve has built up enormous credibility as the guardian of price stability and has wrecked whatever credibility it had as the guardian of low unemployment. A situation in which
the general expectation is that the Federal Reserve will do too little to guard against high unemployment is worse than a situation in which the general expectations is that the Federal Reserve will too
little to guard against inflation--"it is worse, in an impoverished world, to provoke unemployment than to disappoint the rentier".[3]
7. The PCE price index is now undershooting its pre-2008 trend by fully 5%: the proper optimal-control response to a large negative real demand shock is not a price level track that falls below but rather
one that rises above the previously-anticipated trend path.
IMHO, you need to reject all 7 of the above points completely in order to think that the FOMC's goal of returning inflation to 2%/year and keeping it there is anywhere close to an optimal-control path for an
institution governed by its dual mandate. I really do not see how you can reject all seven.
Moreover, financial markets right now believe that the Federal Reserve's policy is not going to attain 2%/year inflation--not now, not over the next five years. Since June the on-track-to-recovery Confidence
Fairy--to the extent that she was present--has flown away:
Thus right now justifying the Federal Reserve's policy track seems to me to require rejecting all seven of the points above, plus rejecting the financial markets' read on monetary policy, plus rejecting the
consideration that depressed financial markets--even irrationally-depressed financial markets--should be offset with additional demand stimulus.
Yet only two of the seventeen FOMC participants are with me. Am I off my rocker? Have they been consumed by groupthink? How am I to understand all this?
970 words
J. Bradford DeLong on September 25, 2014 at 08:04 AM in Economics, Economics: Macro, Equitable Growth, Highlight | Permalink
Comments
1
Edward Lambert said...
Beware the Fisher Effect... persistently low nominal rates alongside weak labor consumption will subdue price and wage inflation as real interest rates yearn for their socially-optimum natural home, which
is comfortably positive at full-employment.
Reply September 25, 2014 at 08:44 AM
2
Donald Pretari said...
I might be an oddball, but I prefer to buy bonds with higher yields. However, if you already own bonds, you do not want to see inflation biting into your investment. You'll lose money, in other words. But the
people who own bonds have already bought them, and so, in the case of corporate bonds, the loan has already been given. In order to get new investment in corporate bonds, you need higher yields that will
attract generally cautious bond buyers. Seeing impending inflation is the way to light a fire under investor's asses to provide new loans to business. This is the best way to help the general economy.
To the people who hold bonds, too bad. You made a bad investment. You were too cautious. Suck it up. Of course, these investors don't do that. Instead, they use the govt tools they own to protect their
investments, and come up with self-serving reasons inflation, and, hence, a growing economy, is bad. Hilariously, people who often claim to target the whole pie end up arguing for a tinier pie that most
accommodates their master's feasts.
This might sound harsh, but I'm saying that real economists, much more intelligent, well-read, and decent, than many of today's specimens, who were small govt enthusiasts, including Keynes, in the 1930s
advocated policies that might personally hurt themselves and some of their chums, because it helped the country overall. In fact, this is main sin FDR committed to many of his chums. FDR was a
conservative, small govt type, who advocated policies against his class and milieu because they benefitted the country overall. After the depression ended, they did indeed get a bit too edgy about the future
of the country, but let's remember where they stood when the chips were down. As Hyman Minsky wrote:
"Neither then nor now do I find what I learned from Simons and Lange to be incompatible. As I see it the socialism of Lange had more in common with the capitalism of Simons than with the socialism of
Stalin, and the capitalism of Simons had more in common with the socialism of Lange than with the capitalism of Hitler. The important thing is not whether property is private and incomes are derived from
owning property, what is important is for society to be democratic and humane.
Between 1937 and 1942, the University of Chicago was a fine place to begin to be an economist. The economists at the University covered a wide spectrum of thought; there was no dominant Chicago School.
The emphasis upon intellectual rigor and seriousness was combined with a wide definition of the subject. Only Lange (and perhaps Douglas) of the senior faculty was sympathetic to Keynes, but perhaps this
was due to the prior acceptance by the other members of the faculty of the need for a strong expansionary fiscal policy during the depression. Having reached this Keynesian policy conclusion by observing
the economy, orthodox economists at Chicago felt no strong need to revolutionize economic theory."
Nor did they feel the need to be some fat cat's poodle.
Reply September 25, 2014 at 01:00 PM
3
Nathanael said...
The FOMC members mostly work for the 0.1%ers, and they're blinkered. You want to understand their attitude? Read _Theory of the Leisure Class_. They're sucking up to the would-be lordlings, and the
lordlings want to stomp the poor and hang on to their nominal wealth.
Remember, FDR was a class traitor. The members of the FOMC aren't; they're mostly suck-up-to-the-rich types. This sort of lickspittle is what you get from the process used to select FOMC members.
Reply September 25, 2014 at 04:30 PM
Comment below or sign in with Typepad Facebook Twitter Google+ and more...
Email address is not displayed with comment.
Name
Email Address
Web Site URL
Post Preview