Here’s a piece from David Leonhardt that has been getting some of play on blogs that I frequent. It’s definitely good to see that more of the profession are coming around to the “quasi-monetarist” view that monetary policy is not impotent at the zero bound, that it can do much more. Here’s David:

Whenever officials at the Federal Reserve confront a big decision, they have to weigh two competing risks. Are they doing too much to speed up economic growth and touching off inflation? Or are they doing too little and allowing unemployment to stay high?

It’s clear which way the Fed has erred recently. It has done too little. It stopped trying to bring down long-term interest rates early last year under the wishful assumption that a recovery had taken hold, only to be forced to reverse course by the end of year.

Given this recent history, you might think Fed officials would now be doing everything possible to ensure a solid recovery. But they’re not. Once again, many of them are worried that the Fed is doing too much. And once again, the odds are rising that it’s doing too little.

Indeed. Myself and others have been emphasizing that the passivity of the Federal Reserve in late 2008 (or, as I like to tell it, the Fed being hoodwinked by rising input costs) was indeed an abdication of its duties…but what duties are those? It’s unclear, because the nature of the Fed’s mandate allows it to slip between two opposing targets at will. Michael Belognia, of the University of Mississippi (and former Fed economist) makes a similar point in this excellent EconTalk podcast. The big issue, as I see it, is the structure of the Fed’s mandate. Kevin Drum (presumably) has a different issue in mind:

Hmmm. A big, powerful, influential group that obsesses over unemployment. Sounds like a great idea. But I wonder what kind of group that could possibly be? Some kind of organization of workers, I suppose. Too bad there’s nothing like that around.

I think this idea of “countervailing powers” needed to influence the Fed is wrong-headed. There is no clear-cut side to be on. Unions may err on the side of easy money…but then again, Wall Street likes easy money* too, when the Fed artificially holds short term rates low. It’s all very confusing. But that’s arguably great for the Fed, because confusion is wiggle room…however it’s bad for the macroeconomy, because confusion basically eliminates the communications channel, stunting the Fed’s ability to shape expectations.

Now here’s the problem as I see it: NGDP is still running below trend, and expectations of inflation are currently running too low to return to the previous trend. Notice, I said nothing about the level of employment. Unemployment is certainly a problem, but the cause of (most of the rise in) unemployment is a lower trend level of NGDP.

Given that you agree with me about the problem, which is the better solution:

  1. Gather a group (ostensibly of economists) to press to rewrite the Fed charter such that the Fed is now bound by a specific nominal target, and its job is to keep the long run outlook from the economy from substantially deviating from that target using any means possible.
  2. Find an interest group with a large focus on unemployment to back the “doves” in order to pressure the Fed into acting more aggressively.

I would back number one over number two any day. And the reason is that while I’m in the “dove” camp now, that isn’t always the case. At some time, I’ll be back in the “hawk” camp, arguing against further monetary ease. Paul Krugman has recently made the same point about using fiscal policy as a stabilization tool. My goal is to return NGDP to its previous trend, and maybe make up for some of the lost ground with above trend growth for a couple years. That would solve perhaps most of the unemployment problem.

But say it doesn’t. Say we return to a slightly higher trend NGDP growth level for the next couple years, and due to some other (perhaps “structural”) issue(s), unemployment remains above the trend rate we enjoyed during the Great Moderation. Would it be correct to say that monetary policy is still not “doing enough”? I don’t think so. At that point, we should look toward other levers of policy that can help the workforce adjust to the direction of the economy in the future.

I’m not say that is even a remotely likely scenario, I’m just trying to illustrate the complexity and possible confusion (and bad policy) that could come out of a situation that Drum seems to be advocating. Better in my mind to have a rules-based policy than an interest group-pressure based policy.

P.S. This was the first post I’ve ever written using my new Motorola XOOM tablet. It wasn’t the hardest thing I’ve ever done, but it was by no means easy. And I wanted to add some charts, but that would be particularly annoying.


*Which, of course, is not necessarily easy money, just low interest rates.

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