If the Fed is inflation targeting, it’s good news for supply-side reforms and bad news for fiscal stimulus.
A recent post by Marcus Nunes pointed out that the Fed doesn’t seem to be interested in NGDP growth, and instead is merely trying to prevent deflation.
Now I get Bernanke
Posted on June 23, 2011 by João Marcus Marinho Nunes
He´s an inflation targeter through and through! And an inflation targeter wants, at all costs, to avoid deflation! That´s all folks! He has no understanding of the benefits from stabilizing nominal spending growth along a target path. He only thinks in terms of inflation/deflation.
I don’t think that’s exactly correct (for reasons I’ll explain later), but he may be close to the truth.
The implications of this are very simple, and easily explained with an AS/AD diagram. Draw a horizontal line for a given price level. The Fed won’t let prices fall below that level, or rise above that level. That means if fiscal stimulus tries boost AD the Fed will offset the effect with tighter money, or perhaps a failure to do QE when needed. But if Obama tries to shift AS to the right, output will increase as the Fed will be forced to shift AD equally far to the right to prevent prices from falling. How might Obama try to shift AS to the right?
1. A cut in the employer portion of the FICA tax, perhaps offset with budget saving elsewhere. That would reduce labor costs (due to sticky wages), without generating any deflationary side effects (due to the Fed inflation targeting policy.)
2. Boost oil supply, by allowing more drilling, or releasing oil from the emergency reserves.
3. Cut the minimum wage and the length of extended UI benefits.
Given that #1 is being discussed and #2 has already been enacted, I’d say it’s a pretty good bet that Obama understands the problem he faces. (Although he obviously has a weak understanding of monetary policy.)
Part 2: Is the Fed actually targeting inflation?
The first thing we need to remember about the Fed is that it isn’t a person, it lacks a mind. It doesn’t have a well thought out policy goal. It responds to many factors, and probably represents some sort of consensus view. Recent statements by Fed officials suggest that they have felt pressure from opponents of QE2, who are much more vocal than supporters. And they’re not just more vocal, probably more numerous as well. A recent survey showed 36 out of 38 economists opposed further monetary stimulus. Even if the survey was biased, that’s a pretty impressive figure. The Fed rarely moves far outside the mainstream, so rather than asking what the Fed believes we should think about what the profession believes.
As far as I can tell, the profession believes many different things, most of which are complete bunk:
1. The view of the quasi-monetarists, and also Krugman/DeLong/Duy/Yglesias/Harless/etc, that we need faster NGDP growth, which means we need more monetary stimulus. Tyler Cowen should also be included in this group, despite the fact that he puts more weight on structural factors than do the others.
2. The typical progressive view that either the Fed can do nothing, or that Fed stimulus merely aids asset holders.
3. The typical conservative view that more AD is not needed, rather we need supply-side reforms.
4. Then there are those who think fiscal stimulus boosts real growth and monetary stimulus boosts inflation.
As far as I can tell, group 1 is a tiny minority within the economic profession. Indeed I think it quite possible that the FOMC is actually more pro-stimulus than the overall profession. QE2 was arguably ahead of the consensus. Actual Fed policy is a weighted average of FOMC views, and the views of the broader profession. This makes it very difficult to talk about the Fed’s objective function. There is probably a reasonable consensus for aggressive stimulus when deflation threatens, as in mid-2010. Many economists focus on core inflation, but many others become frightened by a sharp uptick in headline inflation due to rising commodity prices and a falling dollar, as in early 2011. And real growth matters at least a little bit. Some economists think AD suddenly ceases to matter when there is some other highly visible problem, like banking distress or real estate collapse. Some don’t want to “bail out” Obama, hoping he’ll fail.
Mix all these views into the pot of boiling stew, and you get some sort of consensus policy objective. No single description can do justice to that complex mixture of strange models, dubious morality, and confused reasoning. It is what it is. Our job as bloggers is partly to persuade the FOMC, but more importantly to persuade our colleagues that they are thinking about these issues in the wrong way. If 36 out of 38 economist surveyed favored more monetary stimulus, I absolutely guarantee the Fed would already have QE3 underway.
PS. Don’t tell me that Bernanke always gets his way. He’s a cautious person. “His way” is partly a reflection of what he perceives as the views of other FOMC members and the broader profession.
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13. July 2011 at 05:39
The point I keep repeating and no one refutes is that those who claim to want AD – do not really want it.
You can’t feel smart for pointing out Japan didn’t really want out of the “liquidity trap” – and then skip over my point.
Massive tax cuts for SMB owners would be a direct pay off to the Tea Party. It IMMEDIATELY gets full GOP House support.
It would also win over a far larger swath of Fed bankers who would suddenly be less concerned with inflation (see Greenspan during Internet bubble).
It is the most immediate direct way of moving AD. It is the ONLY politically feasible way of getting it done.
—-
And not Obama, not DeKrugman, not Matty have ANY desire to take that action.
Which means they do not care about AD.
So please stop insisting they do.
13. July 2011 at 05:55
Scott. These are not “normal” times, as I argue in this post (A divided nation).
http://thefaintofheart.wordpress.com/2011/07/13/a-divided-nation/
In that case I concede you could be right when saying that Bernanke reacts to the views of economists. So, unless Obama “plays” FDR it will be a slow slog to get out of the “hole”.
13. July 2011 at 06:33
And marcus skips my point too.
Obama can’t be FDR, but he could immediately hand massive tax cuts to the SMB crowd and move that AD line.
Since he doesn’t / won’t… let’s stop saying he wants to increase AD, ok?
Thanks!
13. July 2011 at 06:46
Marcus, leadership might help, or it might cause the fed to react negatively, like theiy’re being pressured to inflate.
Morgan, How dare Marcus ignore you comment! Seriously, I thought you wanted him to move the AS line to the right–aren’t you a conservative? Or are you saying that more AS would cause the Fed to do more AD, which was my point.
13. July 2011 at 06:53
Note how the markets reacted this morning to Bernanke saying that further monetary stimulus isn’t off the table. Very positively.
13. July 2011 at 07:01
In dire situations, leadership is all! And it´s also “infectious”. In the 1930,s, the Fed stayed on the sidelines (didn´t rock the boat”) for almost 4 years!
13. July 2011 at 07:10
Scott
In his statement before the House Bernanke says:
“The possibility remains that the recent economic weakness may prove more persistent than expected and that deflationary risks might re-emerge, implying a need for additional policy support,” Mr. Bernanke said, suggesting the central bank had several ways to ease financial conditions if necessary.
A replay of the August 27, 2010 “hint” of QE2 at Jackson Hole.
Stocks UP, 10 year Rate UP!
13. July 2011 at 07:10
Notice the emphasis on “deflation risks”!!!
13. July 2011 at 07:22
Forgot: The dollar down!
All according to script. Why the hell doesn´t he do something more “permanent”. Instead of QE´s on and off, a Nominal Level Target?
Morgan, I know, “nobody” wants that.
13. July 2011 at 08:07
” Boost oil supply, by allowing more drilling, or releasing oil from the emergency reserves.
More drilling now will not increase the oil supply for many years and is therefore irrelevant to the current problems the economy is facing. But releasing oil from the emergency reserves will work. But the Obama administration is being beat up by the usual conservative spokesmen for doing this.
13. July 2011 at 08:29
Another good post by Sumner. At the risk of playing amateur psychiatrist, yes Bernanke does not appear to be as “strong” as, say, a Volcker. Bernanke appears to be a cerebral, cautious intellectual type. That means Bernanke prefers to get along with other people.
Getting along is a perfectly admirable trait, unless it means adopting the wrong policy.
Bernanke must know from his 1990s reports on Japan that we need more stimulus (yes, with structural reforms, but we need stimulus even if get no structural reforms).
I can only implore bloggers such as Sumner and others to keep up the drumbeat for more stimulus, and keep up the warnings about Japan. Refer to the current Fed policy as “weak” or “feeble.”
Warn about declining American influence in the world, as our monetary policy suffocates a once-vigorous economy. Warn that our prestige will fall with our shrinking economy. Maybe toss in a line about soldiers returning from overseas duties to find no jobs.
13. July 2011 at 08:47
Option #1 for shifting AS was done in that tax deal last December; although it was small and temporary, 2% through 2012.
There are lots of other ideas for shifting AS; some were proposed at the Chamber of Commerce gathering last week (video available on cspan.org). Some of them were about streamlining regulatory actions, and making congress a part of the rule making process. That seems like a somewhat moderate approach compared to some of the more radical elements on the right that want to just can many of the Federal regulatory agencies and turn them over to the States. I doubt Obama will go for any of them on ideological grounds; and I’m not even sure congress would go for it either since they would actually have to pay attention to what’s going on and do some real work. So, I’m not holding my breath waiting for these until there’s a change in the political atmosphere.
I’m not an economist, only an interested observer (I know enough to get into trouble) and so my question is: Can the Fed have an impact when there are likely quite a few things on the supply side that are suboptimal, like excess cost and delays from regulation? If we don’t do anything at all for the supply side, is it even possible for monetary stimulus to dig us out of the hole or will the Fed just have to keep pumping out rounds of QE to infinity to avoid the “soft patches?” And what are the consequences of trying to keep the economy afloat that way? Suppose the Fed were to adopt NGDP level targeting today. Would that negate the need to adopt supply side reforms, or would we still need to do at least some to keep from ending up with too many dollars floating around?
13. July 2011 at 09:07
Morgan I agre that the people you mention don’t really care about expanding AD(or else they would propose tax cuts that you favor or the elimination of payroll taxes…which the working middle and lower classes would benefit from more than the upper 1%.)
However, all evidence points to the idea that the vast majority of republicans are not interested in this either.
Eliminate payroll taxes all together and pay for the difference with money printing. That would get a the economy growing guaranteed. Something tells me the PTB do not really want the predictable inflation that would result in. Instead they want the slow squeeze on the middle class.
13. July 2011 at 09:25
Gabe,
I firmly disagree. IF progressives TRULY hand conservatives MASSIVE tax cuts on SMBs… far beyond employer side payroll tax holiday…
I’m talking real “holy shit” tax cuts until we have AD back at trend – the GOP will snatch them up AND the Fed will tolerate higher inflation.
What’s more if progressives wanted to be super politically tricky they could make sure that ALL the break went to SMBs (the Tea Party) and none went to Fortune 1000 – and it would be IMPOSSIBLE for Boehner and McConnell to fight it.
The Tea Party rules this country, and if they are truly appeased anything is possible.
—-
Scott, my point still stands, this is about you and nunes et al not asserting progressives want to raise AD.
They don’t. Raising AD is just the excuse for what they want to do – give free shit to poor people.
In the future refrain from saying it. Instead say, “Progressives like DeKrugman, who just want to give free shit to poor people pretend they want to raise AD….”
13. July 2011 at 10:33
John and Marcus, Thanks, I have a new post. Yes, he needs to get ahead of the curve, not always playing catchup.
Full Employment Hawk, You said;
“More drilling now will not increase the oil supply for many years and is therefore irrelevant to the current problems the economy is facing.”
No because oil markets are forward-looking. The expected future supply affects current prices. I’ll grant you that the effect would be small.
Benjamin, I agree about Bernanke being non-forceful.
Bonnie, You said;
“Option #1 for shifting AS was done in that tax deal last December; although it was small and temporary, 2% through 2012.”
No, it was the employee side, which doesn’t help.
Yes the Fed can do a lot. The supply side has problems, but nowhere near enough to explain 9% unemployment.
13. July 2011 at 11:06
Excellent post, Scott. I’ve been thinking similar thoughts (albeit in less impressive fashion). Regarding option #2, I’ve heard suggestions about releasing oil from the reserve, but I don’t believe it’s actually been done. Did I just miss it?
Regarding presidential leadership, I think it depends. If Obama were to come out and say, “The Fed should do X,” that would likely backfire. On the other hand, there are still two vacancies on the Fed, and Obama has every right (in fact, the responsibility) to fill them. I don’t believe he’s even named nominees to fill those seats yet. It would be nice if he would get on that soon, and maybe name a couple of guys that are willing to cast dissenting votes if the Fed doesn’t do enough. This unanimity in favor of muddling through is getting tiring.
13. July 2011 at 11:41
“Regarding option #2, I’ve heard suggestions about releasing oil from the reserve, but I don’t believe it’s actually been done. Did I just miss it?”
Yeah, you missed it. (On the beach that week, I hope.) You don’t get much more “it’s happening” than this:
http://www.spr.doe.gov/doeec/Notice_of_Sale%20DE-NS96-11PO97000/NOSDRAWDOWN2011.pdf
Googling “strategic petroleum reserve” will give lots of commentary, both pro and con.
13. July 2011 at 11:55
Thanks, Fred. Don’t know how I missed that. (Sadly, I can’t blame the beach for my ignorance.)
13. July 2011 at 14:35
Alexander, I agree.
13. July 2011 at 18:19
Scott,
I tried to draw the curves. Doesn’t the price level have to start above the AD/AS equilibrium? That creates more supplied at that price than demanded (ie. insufficient AD). Then when you increase AD through gov’t spending, shouldn’t it add to real growth and not to inflation?
13. July 2011 at 18:34
“No because oil markets are forward-looking. The expected future supply affects current prices. I’ll grant you that the effect would be small.”
While the futures markets are definitely forward-looking, I seriously doubt if they look forward SO FAR that expected increases in oil several years down the road affect the futures prices now.
14. July 2011 at 08:05
Charlie, The economy is at the intersection of AS/AD.
FEH, I’d guess if the 3 year forward price rose $10, the spot price might rise $2 or $3
14. July 2011 at 17:05
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