...the Fed’s policy stance is considerably more accommodative than it was five years ago.Of course, in terms of what the Fed says it cares about (the twelve-month rate of increase in the pce deflator and the unemployment rate), the Fed has been considerably more accommodative than it would have been, pre-2008, if the same state of the world had occurred, as I pointed out here. Thus, the behavior of the FOMC has changed. Either it cares about some things it did not care about before (and in a particular way), or it cares about the same things in different ways - in particular it is less concerned about its price stability mandate.
The Fed may have good reasons for changing its behavior. If so, Fed officials should articulate those reasons in public, so that we can debate the issues. That seems to be what Kocherlakota is attempting here, and he goes even further than you might expect. His conclusion is:
...monetary policy is, if anything, too tight, not too easy.If you have not fainted and fallen on the floor, take a couple of deep breaths, and we'll figure out what Narayana has on his mind. His argument is:
1. We had a big shock, and this calls for extreme measures.
2. The current inflation rate is too low.
3. Forecast inflation is too low:
Current monetary policy is typically thought to affect inflation with a one- to two-year lag. This means that we should always judge the appropriateness of current monetary policy using our best possible forecast of inflation, not current inflation. Along those lines, most FOMC participants expect that inflation will remain at or below 2 percent over the next one to two years.
Big shock: Of course we had the big shock - four years ago. Now, in 2012, what is it about that big shock that creates macroeconomic inefficiency that can be corrected by central bank action - and by central bank action that has not already been executed? Prices and wages are so sticky they have not adjusted? We are in the midst of some coordination failure that Ben Bernanke (or Narayana Kocherlakota for that matter) can fix? What? There has been massive intervention on an unprecedented scale, and the Fed was in the midst of a transformation of the maturity structure of its asset holdings when it embarked on its most recent asset purchase program. How much is enough? I'm sure you don't have any idea, and I'm afraid the Fed, in spite of its brave front, really has no idea either.
Is the inflation rate too low? It depends how you measure it. The Fed's inflation target is 2%, as measured by the pce deflator. The inflation rate, August 2011 to August 2012, is 1.5%, which is the number Kocherlakota uses. From September 2011 to September 2012, the number is 1.7%. If we look at a shorter horizon, the annualized percentage increase in August was 5.0%, and in September was 4.7%. If we look at a longer horizon, as I did here, from the beginning of 2007 or the beginning of 2009, you'll get something a little higher than 2.0% (I didn't have the most recent observation in the chart in the previous post). Too low? I don't think so.
Monetary policy should respond to forecast inflation, not actual inflation. You would think Kocheralakota would know better. Does a forecast give us any more information than what is in the currently available data? Of course not. It's the currently available data that we use to make the forecast. Further, the "best possible forecast of inflation" is not very good, in general, and the Fed's forecast of inflation is suspect. Any economic forecast is 90% judgement and 10% model, and the judgement of Fed forecasters is going to drive the forecast to something that justifies current policy actions. Arguing that the the Fed's forecasts could justify a more accommodative policy than what we already have is nonsense.
On April 8, 2010, Kocherlakota said this:
Deposit institutions are holding over a trillion dollars in excess reserves (that is, over 15 times what they are required to hold given their deposits). These excess reserves create the potential for high inflation. Suppose that households believe that prices will rise. They would then demand more deposits to use for transactions. Banks can readily accommodate this extra demand, because they are holding so many excess reserves. These extra deposits become extra money chasing the same amount of goods and so generate upward pressure on prices. The households’ inflationary expectations would, in fact, become self-fulfilling.So the Kocherlakota of 2 1/2 years ago had some worries about the potential for inflation. Maybe he changed his mind for good reason? I don't think so. The new Kocheralakota seems to be a flimsy-excuse guy.
Addendum: Kocherlakota goes on in the same speech I quote from in the last paragraph to say this:
I hasten to say—and I want to stress—that I view this scenario as unlikely. For it to transpire, the country would need a combination of bad monetary policy and poor fiscal management. I do not foresee this combination as likely to occur.That's important. We now have bad monetary policy and poor fiscal management (whoever is elected President next week - worse if it's Romney). The stunning thing here is that the old Kocherlakota didn't imagine that he would be the source of the bad monetary policy.