Here’s Tyler Cowen:
The Fed thus could make an error on either side of its target, through no procedural fault of its own. As a result, as a simple matter of logic, the rate of price inflation could be too high, or it also could be too low.
if you think you know the direction of the error in advance, you aren’t paying enough attention to the underlying unpredictable uncertainties.
If by “know” Tyler means, “know with certainty” then he is correct. But while we may not know with certainty (or even a high level of confidence) what will happen in the future, it’s possible to know with a high level of confidence what is currently expected to happen. There are many ways to ascertain inflation expectations, and all of the methods that I am aware of point to expectations of unusually low inflation going forward.
TIPS spreads, fed funds futures prices, recent CPI readings, commodity prices, wage cuts, and private sector forecasts all point to lower inflation going forward. None of those are foolproof, but where is the evidence of higher than normal inflation expectations?
If we assume that policy should be set in a position where it is expected to lead to on-target outcomes, then we can be highly confident that the current stance of monetary policy is too tight, probably much too tight.
Let’s say the Fed does the very best job possible with its monetary policy (and in my view the Fed has done a very good job so far). That would mean in terms of the loss function a Fed error in one direction would mean a too low rate of price inflation, and a Fed error in the other direction would mean a too high rate of price inflation.
Now, supply conditions have never been so volatile in my lifetime, and perhaps never in American history. We don’t know how the virus will spread, how reopenings will go, when a vaccine will arrive, how good the vaccine will be, how much a climate of fear will persist, and so on. Demand conditions in turn depend on how these supply conditions will evolve.
I would say that when the Fed is doing a “very good job” then demand conditions do not depend on supply conditions. At least not over the medium term (say in 2021.) If the economy is still in lockdown in 2021 then you can argue that it’s appropriate to let demand conditions be partly determined by supply conditions. I don’t expect the economy to be in lockdown in 2021. And “moderate social distancing” is not a sufficient excuse.
One final point. Don’t confuse “doing better than the ECB and BOJ” with doing a good job. Don’t confuse “doing better than the Fed would have done in earlier decades” with doing a good job. Don’t confuse taking unprecedented steps with doing a good job. Don’t confuse being the best Fed chair in Fed history with doing a good job. Doing a good job means setting policy at a level expected to lead to on-target outcomes for the nominal aggregates that you are targeting. Lars Svensson’s “targeting the forecast” is the only valid criterion for evaluating Fed policy.
If the Fed can’t do a good job for political reasons, then say so. Say the Fed can’t do a good job for political reasons, and point fingers at who is stopping the Fed. But we shouldn’t call it a good job if political constraints are forcing a sub-optimal policy.
The Fed is not to blame for the current elevated rate of unemployment. But the Fed likely will be partly to blame for high unemployment much sooner than most economists recognize. Perhaps even by later in the year.
PS. When I say that inflation is likely to run below 2%, I mean in terms of a price level trend line from the end of 2019. In other words, the average inflation rate. I certainly recognize that there will be a few months of above 2% inflation when oil prices bounce back up.
READER COMMENTS
Alan Goldhammer
May 23 2020 at 9:16pm
I don’t think the Fed has much power at all about the unemployment rate. I’m tracking the hospitality sector which has been really hard hit. Look at the BLS page on this and you see an almost 40% unemployment rate. I have not looked in depth at the travel related industries but they are taking a hit as well. One analyst that I heard today said it would be very bad for restaurants and bars as 1/3 of the population (those older but with the most disposable income) will be reluctant to go into bars and restaurants until there is a better idea of risk. The younger third will probably go back right away and the middle third will be fence sitters. This is not the recipe for a sector recovery.
Philo
May 24 2020 at 3:30pm
The Fed may be unable fully to counteract the increase unemployment due to Congress’s very generous provision of unemployment benefits; also, there will be considerable frictional unemployment, as those who formerly worked in hospitality/travel look for other jobs. But both these factors will probably be important only in the fairly short run.
P Burgos
May 24 2020 at 8:06pm
I second that. I believe that the US got to 11 or 12% unemployment in 1982, but was back down to 7% by the end of 1984. The simplest way to think about is via market expectations; the market doesn’t think that inflation will pick up after the pandemic is over, which is exactly what you would expect if the Fed were pursuing a policy of tight money. Because really, after the pandemic there should be a burst of inflation and hiring as people all over the world celebrate by taking trips, going to restaurants, concerts, movies, etc, etc. The market doesn’t seem to think that the Fed will let that happen.
Thomas Hutcheson
May 24 2020 at 8:56am
I find it odd that SFIK no journalist, political scientist, or social anthropologist (or Vox Ex plainer) has investigated this strange behavior of the Fed. Why has no member of Congress asked at the semi annual hearings? In a way it is even more odd than the collapse of expectations in 2008-09. Then there was very overt political pressure from people predicting hyperinflation. Who today is saying that?
Is Powers better than Bernanke-Yellen? You would not know it from his absurd plea to Congress for more stimulus. (If he just meant more relief for the unemployed and S&LG, he was right substantively but out of line institutionally.) It is true that in Nov 2008-January 2009 the TIPS rate remained below the lowest rate for 5-year expectations recorded post February 2020, 0.14 on March 19. But on the other hand, at no time in Powell’s chairmanship, even in summer 2018 when there seems to be a consensus more stimulus was needed, has the 5 year rate ) or even the implicit 6-10 year rate) flirted with 2.5% CPI which is about what 2% PCE means.
[Looks like the spam filter over at TMI is still blocking my address. Thanks]
Scott Sumner
May 24 2020 at 11:57am
Most people, even many economists, look at Fed policy in terms of Fed gestures, not results.
P Burgos
May 24 2020 at 8:16pm
I thought that AOC had actually asked Powell some sharp questions at some of his reports to Congress about a lack of sufficient concern for the full employment part of their mandate. And Vox had an explainer about things that the Fed could still do to further support the economy in which they mention the group Fed Up, which appears to want to try to get the Fed to have better policy. But no one seems to know what the Fed is thinking. Even Bernanke’s own account of his time leading the Fed doesn’t explain why they felt politically constrained about adopting NGDP targeting, only saying briefly that there was agreement that it was superior to an inflation target but that they didn’t think that it was worth the political blowback. But he never specified who they were actually afraid of, or why. So I suspect that if Bernanke isn’t willing to name names, the fear must be very strong and there must be a strong taboo about openly discussing who and what the Fed fears.
Todd Ramsey
May 24 2020 at 10:34am
Perhaps we should celebrate that the Fed is getting better, rather than only lamenting they aren’t perfect.
Is it possible that actual inflation over the next 10 years will exceed today’s expected inflation as indicated by the TIPS spread? The TIPS spread in December 2008 was about 0.15% and actual CPI inflation over the next 10 years averaged about 1.6%. And if so, should we be wary of the possibility of accelerating inflation after unprecedented money creation to finance the wave of federal government spending? And if so, is the Fed possibly correct in not creating even more money?
Scott Sumner
May 24 2020 at 11:58am
Todd, You said:
“Perhaps we should celebrate that the Fed is getting better, rather than only lamenting they aren’t perfect.”
Why not both?
And notice that TIPS spreads are just one of many indicators suggesting low inflation going forward.
Philo
May 25 2020 at 12:09pm
Critics view most monetarists’ prescriptions for Fed policy as being very hard to execute: bringing in inflation or NGDP or whatever right on target would be inhumanly difficult. Scott’s prescription, Target the Forecast–which would be easy to execute–is generally not well grasped.
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