Greg Ip from Jackson Hole: Speeches by Feldstein and Taylor

Greg Ip reports from the Federal Reserve conference in Jackson Hole on speeches given by Marty Feldstein and John Taylor:

Two Heavyweights Weigh in on Greenspan’s Legacy, by Greg Ip, WSJ Economics blog: Provocative speeches by two of academia’s most prominent economists... [Martin] Feldstein ... delivered a gloomy forecast of the impact of the unraveling housing boom and argued that if the Fed cared about unemployment and not just inflation, there should be “a major reduction now in the federal funds rate — possibly by as much as 100 basis points (one percentage point).” ...

Mr. Feldstein told the Federal Reserve Bank of Kansas City’s annual symposium in Jackson Hole that the economy faces three threats: home construction collapses as prices plunge, credit freezes up, and consumers’ spending wilts as they lose the ability to borrow against their homes’ value. “Experience suggests that the dramatic decline in residential construction provides an early warning of a coming recession. … If the triple threat from the housing sector materializes with full force, the economy could suffer a very serious downturn.”

Then, employing “risk management,” Mr. Feldstein asked what would be the consequences if the Fed cuts rates but discovers the threats didn’t materialize: “The result would be a stronger economy with higher inflation than the Fed desires, an unwelcome outcome but the lesser of two evils. ...” This “risk-based approach in the current context” he suggested, “is not an abrogation of [the Fed’s] fundamental pursuit of price stability.” ...

Stanford University economist John Taylor, author of the famous “Taylor rule,” ... says the Taylor rule would have told the Fed to raise the federal funds rate from 1.75 % in 2001 to 5.25% by mid-2005. Housing starts, around 1.6 million in 2001, would have peaked at 1.8 million (annual rate) in early 2004 then begun a gentle decline. In reality, the Fed cut the rate to 1% in 2003, then began raising it in 2004, only reaching 5.25% in mid-2006. Housing starts soared to 2.1 million by early last year and have since plummeted, to around 1.5 million. “A higher funds path would have avoided much of the housing boom … The reversal of the boom and thereby the resulting market turmoil would not have been as sharp,” Mr. Taylor said.

Mr. Taylor acknowledges the Fed had good reasons to err on the side of easy policy and that low long-term interest rates also boosted housing. But he argues long-term rates were low in part because investors may have seen the Fed’s easy policy as evidence of a permanent de-emphasis of inflation, making long term rates less responsive to the Fed. The lesson, he says, is that when the Fed departs from business-as-usual, ... it can be “difficult for market participants to deal with and lead to surprising changes in the economy.” ...

Mr. Bernanke indicated Friday that the threats Mr. Taylor warned of could lead to rate cuts. Still, the rest of the economy remains in reasonably good shape. Whether that remains true after the current turmoil has run its course will be an important factor in Mr. Greenspan’s legacy.

Markets seem far more certain of a rate cut than the signals coming from the Fed would indicate. I'll be interested to see if the rate cut probabilities change on Monday, or thereafter, though I don't expect to see much change without some important new piece of information coming to light. [More on the conference here and here.]

Comments

[esb]

Ip, in his appointed role as "the designated leakee" is waiting around for the leakers (or is it "leakors") to, well, leak.

With all of the talk about "conduits" perhaps he is the conduit who matters most.

We are all waiting, Greg. What's taking so long, boy?

[bullbust]

“The result would be a stronger economy with higher inflation than the Fed desires, an unwelcome outcome but the lesser of two evils. ..."

Lesser of two evils? For whom?

These know-it-alls were all quiet when the obscenely rich made out like bandits under Greenspan's low interest regime. No hedge fund or IB was left behind - as the profits rolled in from the debts of the middle class and the poor.

Now, when it is all about to come crashing down, inflate. Let the middle class and the poor fight among themselves for the scraps.

These economist elite detached from reality do not care about the real people. For the elite its all a machine. They twiddle the knobs and play. They have their tenure and connections and think-tank welfare. Their welfare is well taken care of.

[dissent]

bullbust, uh, no.

"No hedge fund or IB was left behind - as the profits rolled in from the debts of the middle class and the poor.Now, when it is all about to come crashing down, inflate."

Perhaps the simplified map of economics I carry in my head has its directions mixed up, but I seem to recall that inflation helps the debtors and hurts the owners of capital, because the real value of capital does down, reducing the real value of debts and eroding the value of capital.

The mission of the Federal Reserve, which prioritizes fighting inflation over a healthy job market, that some might say was a problem.

[Winslow R.]

Mark wrote: "Markets seem far more certain of a rate cut than the signals coming from the Fed would indicate. "

Could read...

Foreign CB's and Opec seem far more certain of a rate cut than the signals coming from the Fed would indicate.

Which is a pretty silly thing to say because a rate cut is probably not even being considered here. The 'mistake' you are making is to think the 'market' is being driven by intermediators - which it is not its being driven by those with cashflow.

Mark as an intermediator
Would you be willing to borrow from the Fed at 5.25% and make a loan back to the government for 3 months at 4.15%. Didn't think so.

Mark as Opec/China etc
If you had 2 billion additional dollars coming in everyday of the year where would you park it right now? U.S. stock market, real estate, gold or 3 month tsy secs? Would you even care if the Fed was going to cut rates in two weeks?

[wimpie]

"If you had 2 billion additional dollars coming in everyday of the year where would you park it right now?"

Depends on the countries and the motive(s) to stockpile claims against the US. If I were a policy maker in China or Russia I would be parking them in Assets that that can be used as leverage against the US but not on the FED's charter to monetize.

Greenspan's "conudrum" was basically, China hijacking US monetary policy to turbo charge their own growth at US long term expense.

If Bush goes to war against Iran(odds seem to be increasing for an attack), we may see what electronic financial war is all about.

In the past trying to massively depreciate an enemies
currency has been used.

[run75441]

Inflation has been kept under control not by fed interest rates at 5.25% but by a over sized and under employed labor pool. There is an over abundance of labor as determined ny an historically low Participation Rate and easy illegal Immigration. Both keep wages low.

[spencer]

We are facing a host of conflicting indicators and it is not clear that the Fed should cut rates.

For example core inflation is clearly moderating. But on the other hand unit labor cost increases are at the top of the band that has existed since the 1980s. If the Fed cuts rates now and the economy does strengthen the odds are extremely strong that unit labor cost growth will break out of this close to 30 year old band to the upside.

When is the last time we saw a discussion of this increase in unit labor cost in the business press? It has suddenly become one of the most ignored economic indicators that the government publishes.

Meanwhile both nominal and real income growth is solid and despite the noise in consumer confidence retail sales growth is clearly not signaling a significant slowing of consumer spending. One of the best indicators of retail stocks relative performance is inflation and suddenly the retailers are starting to outperform as reported inflation moderates and investors anticipate a Fed easing. Retailers are the classic first out of the block sectors to buy at the start of a new bull market.

[calmo]

Such a startling contrarian view spencer. The decline of MEW having the effect of making employees more adamant about real increases in their wages/salaries...?
Do we need to examine this bit:
But on the other hand unit labor cost increases are at the top of the band that has existed since the 1980s. Could it be health costs embedded in those labor costs are the reason? With the downturn in housing, could we be feeling the end of those higher wages in that large (and scandalously generous) sector? If the wage component of those labor cost increases are the reason, why isn't it reflected in higher new car sales?
And maybe this bit:Meanwhile both nominal and real income growth is solid and despite the noise in consumer confidence retail sales growth is clearly not signaling a significant slowing of consumer spending. The back-to-school periods of course are "seasonally adjusted" but the "noise" from WalMart, the low-end retailer? Or could those consumers who are facing refinancing difficulties approaching this business in the same fashion as they did their mortgage brokers...with less than due diligence (like the general population...right on up to The President)? Some people (ok, me for instance) feel that whatever the merits of the most recent stats, the next few quarters contain BAD news with that ~$700B worth of re-financing.
But as always with you, I am listening.

[INUBILE EKUNDAYO]

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