Jim Bullard Responds to Tim Duy

Via email, Jim Bullard, President of the St. Louis Fed, responds to Tim Duy:

Hi Tim,

I read your "Fed watch" column this morning in our news clips.  You do an excellent job of summarizing important issues facing the FOMC.  I have three comments, all of which I have made publicly recently, and I think they are critical ones for the direction policy will take:

--on the "raising interest rates" question:  I am not sure if you have looked at my paper, "Seven Faces of the Peril," but if not please take a look at Figure 1 there (web page below) and contemplate the left hand side of the picture.  This convinces me that staying with the near-zero interest rate policy alone--and promising to stay near-zero for a long time without doing anything else--risks a deflationary trap.  To avoid this, I am recommending additional QE as a supplement to the near-zero rate policy as our best option.  You actually have one of the world's experts on the question of the dynamics behind Figure 1 at the U. of Oregon: George Evans.  Rajiv Sethi's summary of this issue as linked in your blog is very good, but citing Howitt--a fine paper, to be sure--is missing the more sophisticated analysis of Evans and Honkapohja that I cite in my paper.  I am not saying I necessarily agree with the Evans and Honkapohja policy conclusions, but they have good analytics for framing these issues.

--on the effectiveness of QE:  I do not agree that asset purchases are somehow ineffective.  I talk about this in my CNBC interview at Jackson Hole (also posted on my web page).  The direct empirical evidence on the effectiveness of QE both in the U.S. and the U.K. is fairly strong.  For example, see the paper by Chris Neely of our staff cited in the "Perils" paper.

--on the "disciplined" QE program:  The quote from Vince Reinhart, who is a great guy, gives the "shock and awe" view of QE.  I do not think this is remotely correct.  We know how monetary policy works:  through the expected future path of policy, not through the actual move on a particular day.  When we make 25 basis point moves on the federal funds rate, those are small viewed in isolation, but they have important effects for macroeconomic stabilization because they imply an expected interest rate path over the coming years.  The same is true for QE.  A move on a particular day may seem small, but it implies a path for future policy, and a series of smaller moves may add up to a very large move if the incoming data are consistent with such an outcome.  The "shock and awe" view, if applied to interest rate targeting, would suggest very large interest rate movements in response to relatively small changes in incoming data, a policy that most would view as destabilizing for the macroeconomy.  The same is true for QE.  So the point is that QE moves should be commensurate with the incoming data (a.k.a. "state contingent").  Of course we can argue about the incoming data--and I know you have strong views on that--but I think my position on a "disciplined" QE program is correct and that the dangerous policy is to make destabilizing moves out of line with the incoming data.  Concerning the data itself, your colleague Jeremy Piger will update his recession probabilities shortly so I will be anxious to see how that comes out.

I hope these comments are not too confused, I enjoyed your blog and I think you do a fine job of tracking the issues in the Fed.

Best regards,

Jim

I am about to do a video with George Evans who will explain the issues involved with dynamics at the zero bound, how Howitt fits in, how learning changes things, etc., so please stay tuned...