Thursday, April 28, 2011

Mark, Brad, and Ben

I thought I would take apart some of the commentary in this forum in the New York Times. There are five people writing here, and most of it is innocuous, except for the first two, Mark Thoma and Brad DeLong. Of course, those two opinions are guaranteed to be extremely close, but maybe the people at the New York Times who set these things up do not know that.

In standard form, Mark Thoma's heart goes out to the unemployed, as mine does. However, Mark is much more certain than I am that the Fed can actually help these people out. Here is what Mark would have asked Ben about, if he could:
The main question I wanted to hear Bernanke answer is, given that inflation is expected to remain low, why isn't the Fed doing more to help with the employment problem? Why not a third round of quantitative easing?
In retrospect, more aggressive action by the Fed was warranted in every instance. Perhaps this time is different — I sure hope so — but the recovery has been far too slow to be tolerable. Green shoots require more than hope, they require the nourishment, and with fiscal policy out of the picture it’s up to the Fed to provide it.
Well, the answer to the question: "Why not a third round of quantitative easing?" should be: "Because it does not do anything." (see here). In retrospect, the Fed could not have done any more than it did, even if you think that sticky wages and prices matter in a big way. Mark may think that the level of employment is intolerable, but the Fed has to tolerate it in the same way I have to tolerate the soggy weather outside.

Now, to take back what I said earlier, DeLong actually discusses something different (though the theme is the same). This is tag team. Thoma does labor market, DeLong does inflation. Brad's problem with Ben is pretty straightforward.
It thus looks like 1 percent is the new 2 percent: with current Federal Reserve policy, we are looking forward to a likely 1 percent core inflation rate for at least another year, and more likely three.
Bernanke has certainly made it clear that, in his view, the Fed has a 2% inflation rate target. It is also clear that he wants to focus on core measures of inflation. We'll take Brad's word for it that PCE deflator inflation, excluding food and energy, is running at about 1%, year-over-year. Clearly that's too low relative to the target, so shouldn't the Fed be doing more to correct that problem?

1. Accommodative monetary policy causes inflation, but with a lag. I think Brad's inflation forecast is on the low side, as maybe Ben does as well. The policy rate has been at essentially zero since fall 2008. Sooner or later (and maybe Ben is thinking sooner) we're going to see the higher inflation in core measures.

2. Maybe Ben is more worried about headline inflation (as I think he should be) than he lets on.

3. Maybe in his press conference Ben did not want to spend his time explaining why the Fed spends its time focusing on core inflation. What every consumer sees is headline inflation, and they are much more aware of the food and energy component than the rest of it.

4. As with my comments on Thoma, there is really no current action that the Fed can take to increase the inflation rate. More quantitative easing won't do anything, so the Fed is stuck with saying things about extended periods with zero nominal interest rates in order to have some influence through anticipated future inflation on inflation today.


  1. Steve,

    Why do you keep saying there is nothing the Fed can do? You acknowledged in the comment section in your last post that the Fed could do something more via a price level or ngdp level target. By more forcefully shaping nominal expectations with such a rule the Fed could do a lot.

    It is worth remembering that folks were saying the same thing about monetary policy in the early 1930s. They were certain there was nothing more the Fed could do and as a consequence of this consensus we get tight monetary policy and the Great Depression. Then FDR came along and change expectations by devaluing the gold content of the dollar and by not sterilizing gold inflows. His "unconventional" monetary policy packed quite a punch.

  2. I'm with David on NGDP targeting. But even if the Fed didn't do that, it has its interest on reserves policy, and the last I checked, it hasn't set an explicit inflation level target, and there is ~$14 trillion in outstanding Treasury debt held by the public that the Fed does not yet own...something Andy Harless has pointed out on numerous occasions.

  3. Steve,

    A couple things. First, what David said.

    Second, why should we take Brad's word about core PCE inflation? We have this stuff called "data" that we can use to see what that inflation measure is now.

    Third, you think Brad's inflation forecast is too low. Fair enough. What model are you using that suggests a higher forecast? (I remember you posted something about how we should focus on headline rather than core, but all I remember is not being convinced.)

    Finally, if there is a 2% target, and the Fed has been consistently missing on the low side, then why should there be an asymmetry in responses? I remember the RBA confronting similar questions in the (I think) late 90's when I was in Melbourne (their target inflation band is 2-3% "over the course of the business cycle").


    PS -- I'll have to read it more carefully, but you haven't convinced me about the irrelevance of QE2 either.

  4. Do any of these measures count in "hidden" inflation, which we've been getting for a while? I'm guessing definitely not. Which to me means there's already higher inflation than people say.

    Second, what affect do you think future inflation expectations are supposed to have on inflation today?

  5. Couldn't QE2 have had some effect through its impact on expectations ? Theoretically, anything can have a sunspot effect, including QE2. Admittedly QE2 was pretty weak tea on the face of it, but if people believe it will have an effect, then it will have an effect.
    e.g. Fischer Black argued that inflation was indeterminate, being essentially expectationally driven, not pinned down by monetary policy.

  6. Steve: I still disagree with you that there is nothing that the Fed can do. I agree with the Chairman that the risks of acting further probably outweigh the benefits.

    David Beckworth: The Fed is a creature of Congress and cannot change its own mandate. About the best that the FOMC can do is officially define "price stability.

    Pete: Why would we look at data when we can argue over the facts? If you must be this way though, PCE inflation is running at 1.7% but inflation forecasts are rising.[1][id]=PCECTPI&s[1][transformation]=ch1

    Niklas: Purchasing the US debt would put us well on the road to being Zimbabwe. I don't want to need a salary adjustment every day.

    Joe Scannua: What is hidden inflation?

  7. @Chris: I'm in no way advocating such a move, just trying to illustrate that while there are assets that the Fed doesn't own (even real assets), there is always something that monetary policy can do.

  8. @Chris ": The Fed is a creature of Congress and cannot change its own mandate."

    It's already changed its own mandate by ignoring it over and over and over again.

  9. "if there is a 2% target, and the Fed has been consistently missing on the low side"

    the Fed has not been consistently missing on the low side. Go read the "price stability" comment in the "Bernanke meets the press" post. As you wrote yourself, "We have this stuff called "data" that we can use to see what that inflation measure is" --- over any reasonable period of time.

  10. psummers is right - we have data! And new data came out today showing core PCE rising 0.9% y/y.

  11. the value in looking in core is that it leads headline (according to the fed - others disagree). this does not seem to imply that core is/should be the target.

  12. Schisma Tism,

    For those of us who can't read your mind, perhaps you could explain what you are talking about.

  13. @Chris: Actually, purchasing the US debt under today's circumstances wouldn't necessarily carry long-run inflationary implications. Since bank reserves pay interest comparable to that paid on T-bills (actually higher), and since the reserve requirement is not currently binding, there is no incentive for banks to lend out the additional reserves created by purchase of Treasury debt. In effect (as Steve argues in the other post to which he links above) the purchase of Treasury securities by the Fed merely constitutes maturity transformation.

    Ultimately, the more long-term debt the Fed owns, the more sensitive its own position will be to inflation. Therefore if it were to buy the entire national debt, it would have a strong incentive to resist future inflation.

    To see this another way, consolidate the balance sheets of the Fed and the Treasury. Then the more Treasury debt the Fed buys, the shorter will be the average maturity of the the combined debts of the Fed and the Treasury. If the Fed were to buy the entire national debt, it would be as if the Treasury had financed everything short term. But if that were the case, the government would lose any advantage from inflation, because any expectation of inflation would require it to refinance its debt at a higher interest rate.

    I made this argument in greater detail here:

  14. @Anonymous,

    Assuming the conventional wisdom that the Fed targets the core PCE deflator, it fell below 2% in December '08 and has been WELL below since:[1][id]=PCEPILFE&s[1][range]=5yrs

    We can argue about what "consistently" means here, but I'd sure call that "missing on the low side."


  15. Here's the thing that's missing for me. The way I understand New Keynesians models, the relevant distortion is nominal wage and price rigidity. The reason that unemployment rate is so high is because nominal wages are still too high, thus monetary policy can correct the problem. To some extent, I think nominal wage rigidity probably does exist simply because I don't think people immediately re-negotiate wage contracts (implicit or explicit) in response to a monetary policy action. But, at the same time, how rigid are wages? The recession started in 2008, are wages really that rigid they are still pegged above market clearing? Call me skeptical. And even if we accept the Akerlof-Yellon argument of downward nominal wage rigidity due to fairness constraints, doesn't employee fairness concerns eventually go out the window when the alternative is long-term unemployment? I know when my boss offered a lot of us a significant wage cut in 2010, in exchange for retaining employment, basically everyone accepted (though, most of us, including myself were high school students - maybe we are less attuned to fairness than adults?). Do Thoma, Delong, and Krugman really believe wages (or prices, but I think that's even more absurd) are that rigid - or is there something more to these models I'm missing? If I'm right in believing that the current labor market issue isn't wage rigidity, the very best I could imagine a policy that these guys are recommending accomplishing is creating a "surprise" inflationary shock (in the sense of the Lucas island model) which temporarily raises output for a couple months and then moves us right back to where we are now - though I doubt this would actually happen anyway.

    I'm confused about Thoma though, I thought he said he didn't believe QE would be that effective. Why bother with a third round if it doesn't help?

    For Delong, perhaps Bernanke is watching inflation expectations measures? According to the Cleveland Federal Reserve's estimates of inflation expectations, as of April 1, 2011, one-year inflation expectations are about 1.9% - which is pretty close to 2%.

    Also, I have to disagree with your suggestion the Fed can't increase the inflation rate. Eventually, banks will no longer desire to hold the current level of reserves. The Federal Reserve can tame this future inflation using the IROR (as I hope they will!), but they also might not. If instead the Fed promised that when the time came they wold not react aggressively and instead were pursuing price level targeting, wouldn't this cause current inflation through the expectations effect? Like I said earlier though, I don't think this would help much.

  16. David,

    NGDP or price level targeting: I'm not sure whether I got across what I was thinking before. At this point in time, I don't think there is any more mileage we can get from specification of an explicit policy rule. There has already been enough talk about the future to squeeze any action out of that that we can.

    Pete: I don't have an explicit model, except what's in my head. However, I don't believe anything that is coming out of the Board's forecasts either (let alone DeLong). I think they have a crappy model for forecasting inflation under the current circumstances.


    What's the hidden inflation you are thinking about?

    Anonymous core leading headline: Read this:


    "Ultimately, the more long-term debt the Fed owns, the more sensitive its own position will be to inflation. Therefore if it were to buy the entire national debt, it would have a strong incentive to resist future inflation."

    That's good. I think there could be something to that. Note that some people made exactly the opposite argument. Kocherlakota (I think) said that the long-maturity asset purchases were a commitment to keep inflation high. His reasoning was that the Fed would not want to increase the overnight policy rate as that would create a capital loss on the assets, and the Fed would avoid that.


    1. Yes, I have the same doubts about price and wage rigidity and their importance currently.
    2. "I'm confused about Thoma though, I thought he said he didn't believe QE would be that effective. Why bother with a third round if it doesn't help?" Yes, he confused me too. Krugman is confusing (or confused) in the same way.
    3. "If instead the Fed promised that when the time came they wold not react aggressively and instead were pursuing price level targeting, wouldn't this cause current inflation through the expectations effect?" I think that is essentially what they are doing with the "extended period" language. That's why I think there is nothing more to do.

  17. @Andy, I know what is going on with the monetary base and paying IOER. Yes, I agree that it is a maturity transformation of govt debt. I would argue that the govt already has little incentive to inflate b/c it borrows too much either short or in real bonds.

    I don't think that undoing this maturity transformation is necessarily going to be without problems though. We are in uncharted waters here.

    I think that I misinterpreted Niklas's post as coming from the Modern Monetary Theory school. My apologies for misinterpreting his comments.

    @Pete, I don't think that the Fed necessarily targets the core PCE but it does use it as an indicator. I think that the Fed is ultimately concerned with overall inflation.