Wednesday, September 19, 2012

Lacker Speech

Here's a speech from yesterday by Jeff Lacker, President of the Richmond Fed. Lacker was the only dissenter at the last FOMC meeting.

The speech begins with a useful discussion of the Fed's dual mandate, in particular how we should think about "maximum employment" in the short run and the long run. Then he discusses the reasons for his dissent. Basically he doesn't like any of the components of the Fed's change in policy - the planned asset purchases, the change in forward guidance, and the type of assets to be purchased.

Lacker argues that more accommodation now is not warranted, for two reasons. First, employment growth may be sluggish and the unemployment rate high, but
... my assessment is that a reasonably strong case can be made that the natural rate of unemployment that corresponds to the Fed’s maximum employment mandate is now relatively elevated.
Second, the Fed is doing fine on the inflation front, particularly relative to where it was at the brink of previous policy interventions.
It’s worth noting that when previous asset purchase programs were adopted in 2009 and 2010, the inflation outlook was significantly different than today. Back then, deflation appeared to be a very real possibility, so further accommodation, whatever it did for unemployment, also helped keep inflation closer to the Committee’s goal of 2 percent.

Lacker thinks the change in forward guidance may raise doubts about the Fed's commitment to control inflation.
The Committee’s statement also altered the “forward guidance” regarding future monetary policy, stating for the first time that it expected a highly accommodative stance of monetary policy for “a considerable period after the economic recovery strengthens.” I disagreed with this statement because I believe a commitment to provide stimulus beyond the point at which the recovery strengthens and growth increases implies too great a willingness to tolerate higher inflation and would be inconsistent with a balanced approach to the FOMC’s price stability and maximum employment mandates.
Finally, Lacker has problems with purchases by the Fed of mortage-backed securities (MBS).
Such purchases, as compared to purchases of an equivalent amount of U.S. Treasury securities, distort investment allocations and raise interest rates for other borrowers. Channeling the flow of credit to particular economic sectors is an inappropriate role for the Federal Reserve. Central banks abuse their independence when they promote some borrowers at the expense of others.
This is an important concern. Even if MBS are close substitutes for Treasury debt, and the decision about whether the Fed purchases MBS or Treasuries matters little, there is a perception that the Fed intends to favor a particular sector of the economy with this type of intervention. If indeed the MBS are not close substitutes for Treasuries, then, as Lacker points out, the Fed's actions will serve to reallocate credit. For example, investment in capital equipment will suffer relative to residential construction.

Lacker should not be characterized as some kind of extreme hawk. His views, as reflected in this speech, are well-reasoned, and well within the mainstream of modern economic thought.

21 comments:

  1. Hi Stephen,

    "Lacker thinks the change in forward guidance may raise doubts about the Fed's commitment to control inflation." By how much? Since the Fed's announcement was a bit of a surprise, wouldn't there have been a larger rise in T-Bond rates then there was if Lacker were right?

    "Channeling the flow of credit to particular economic sectors is an inappropriate role for the Federal Reserve. Central banks abuse their independence when they promote some borrowers at the expense of others." This is a reasonable concern. But suppose buying MBS were, in fact, the best means of achieving the dual mandate. Should the Fed still reject it?

    "If indeed the MBS are not close substitutes for Treasuries, then, as Lacker points out, the Fed's actions will serve to reallocate credit . . . investment in capital equipment will suffer relative to residential construction." All else equal, then sure. But what if improvements in the housing sector spill over to other sectors, and there's an increased demand for capital equipment. Couldn't this easily override a modest increase in interest costs for the producers of capital equipment?

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  2. "By how much?"

    That's the key question of course. Lacker's made some assessment of this and thinks it matters enough for him to dissent.

    "But suppose buying MBS were, in fact, the best means of achieving the dual mandate."

    You can suppose a lot of things. What if you get the same effect on aggregate activity from Treasuries as from MBS? What if both give you nothing?

    " But what if improvements in the housing sector..."

    Sure. We need to think about general equilibrium effects, in general. But there's still reallocation toward housing. The key problem he seems to be worried about is that this opens the door for various interests in society to start lobbying the Fed, and Congress, to help their sector, or even their specific firm. Maybe Boeing would like the Fed to buy its debt. Maybe General Motors would like the same thing.

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  3. "Maybe Boeing would like the Fed to buy its debt. Maybe General Motors would like the same thing."

    That is a very good point, and a cause for concern.

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    1. By the same token, maybe people holding T-Bonds would like the Fed to buy T-Bonds, and maybe people shorting T-Bonds would like the Fed to sell T-Bonds, and maybe borrowers would like low interest rates, while creditors would prefer higher interest rates. It's not as if Fed policy leaves everyone equally happy or sad.

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    2. That's certainly true. There are distributional effects of any policy. This makes it more obvious though.

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    3. As a sidebar, Oskar Lange defended socialism against the Austrians by arguing that central planners don't have to set all prices, only the rates of interest at which various industries may borrow.

      Is this a good idea? It certainly runs against the grain of orthodox "free market economics." But when one takes account of the many real-world market imperfections, perhaps the use of differential interest rates, e.g., lower interest rates for industries with positive externalities, could be a better approach than, say, tax subsidies for such industries. Of course there are drawbacks; just sayin'.

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    4. In this instance, I think you'll have a hard time arguing for the externality, though some people try. We're somehow a better society because people own their houses? We already do a very good job of subsidizing the housing sector. Hard to see why the Fed needs to add to that.

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  4. Greg,

    I would be more likely to agree if the Fed adopted a rule and was explicit about it. My problem is that the Fed has too much discretion if it can buy bonds issued by any industry or company as it sees fit. This undermines its credibility, and is likely to generate various theories regarding its "true" motives.

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  5. Stephen,

    I wasn't thinking of housing, though, at the present time, it's not an implausible candidate. Perhaps the Fed should buy bond issued by the 50 states in some proportion that's reasonable fair. Alternatively, the Fed could buy the bonds issued by states with unemployment in excess of some figure.

    CA,

    Yes, rules would be preferable, but sometimes you've got to trust the judgment of those in charge, provided they are eventually held to account.

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  6. "Perhaps the Fed should buy bond issued by the 50 states in some proportion that's reasonable fair."

    This is why the EMU is in trouble. What seems fair to Greece does not seem fair to Germany.

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    1. "What seems fair to Greece does not seem fair to Germany."

      It's not just a question of fairness, of course. Germany seems more willing to help today than it was three months ago, but probably not because Germany has come round to the Greek view of fairness.

      The U.S. government (though not the Fed) seems to have been able to agree on various bloc grant formulae for distributing federal funds to the states.

      In addition, the Fed wouldn't be "bailing states out," but, hopefully, would be reducing the interest costs of state-financed capital projects. All states could benefit directly via lower interest rates on bonds used to finance their capital projects, and, indirectly, as each state's capital expenditures increase incomes other states.

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    2. Look at Tom Sargent's Nobel address. He has something to say about this:

      http://www.nobelprize.org/nobel_prizes/economics/laureates/2011/sargent-lecture.html

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  7. Stephen,

    I actually did watch Sargent's Nobel speech, enjoyed it, and recommended to some Keynesians.

    I think he made the point that the new U.S. Federal Gov't. set aside moral hazard concerns and made good on the states's outstanding bonds. He seemed a little ambivalent, to me at least, on whether this experience should guide the Europeans.

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    1. He mentioned one occasion where the government did step in and bail out, and another when it didn't.

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  8. "provided they are eventually held to account."

    Government, including the Fed, is designed to avoid accountability. Arthur Burns is widely viewed as having screwed it up and there is certainly no argument that he compromised the independence of the Fed for Nixon's political gain. How was he held accountable? Did he lose his job? His pension? Was he investigated and/or prosecuted?

    Or what about Tim Geithner? A tax cheat who screwed up monetary policy. His punishment was to be promoted to Treasury Secretary. He should be on Elba

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    1. Anon,

      You seem to want to conclude from a few examples that public officials can't be held accountable, that government is "designed to avoid accountability." I'm sympathetic to your concern, but don't find your conclusion compelling. Among the various forms of government, democracies seem to outperform all the others.

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  9. A "few"? If only! I recommend, as a starting point, "Throw Them All Out" by Peter Schweizer, which provides a more systematic study of government malfeasance (and is non-partisan in its targets).

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  10. Okay, the argument goes that the natural rate of unemployment is elevated, but promoting a policy that might elevate inflation above 2% is dangerous.. I agree that the reallocation of credit towards housing is not necessarily desirable for US industrial needs, but I don't understand why an inflation rate above 2% is considered problematic in a recessed economy unless there's evidence that inflation is accelerating upwards. To the contrary, since September 2011, inflation has consistently fallen and now hovers around 1.7 (historically very low). http://goo.gl/iXZmK . So then the issue must be qualitative? That a high inflation rate is inherently more detrimental to the greater economy (arguably in terms of growth) than a high unemployment rate. I think, however, when the scope of the debate is significantly reduced as it has been, inflation is merely more detrimental to some parties, while high unemployment is more detrimental to others.

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  11. I don't want to put words in Lacker's mouth, but he seems to be saying: (i) me may not like the high unemployment, but we're going to have to live with it for a while; monetary policy can't do much to make the unemployment lower at the moment. (ii) You shouldn't take lightly the possibility of inflation going above 2%. Once you allow that, it's going to be very hard for the Fed to convince anyone that it is serious about inflation control, which is its primary job.

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  12. @Greg Hill:
    http://www.bloomberg.com/news/2012-09-28/obama-cabinet-flunks-disclosure-test-with-19-in-20-ignoring-law.html

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  13. @Greg Hill: it appears that allowing a breach of security at a government storage facility for weapons-grade uranium results in nothing more than the relevant officials being "reassigned". Is there such a thing as a "firing offence" in government?

    http://uk.reuters.com/article/2012/09/29/uk-usa-nuclear-gaf-idUKBRE88S0F120120929

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