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Friday, November 07, 2014

Fed Watch: Nonsense

Tim Duy:

Nonsense, by Tim Duy: I stumbled across this piece in The America Spectator in which the authors argue against the prospect of the Federal Reserve pursuing a "triple mandate" by adding inequality to the current mandate of price stability and maximum employment. They claim the current mandate itself is unworkable:
...Replace the Fed’s current dual mandate with a single mandate—keep the price system as honest and stable as possible.
The dual mandate creates a contradictory tension that makes it practically impossible for the Fed to function effectively...
...The Fed currently finds itself unable to pursue that kind of price stability, because its unemployment mandate gets in the way. The Fed can induce a temporary boom by unexpectedly boosting inflation...
...If the Fed tinkers with interest rates and the money supply in an effort to reduce inequality, it puts further obstacles in the path of entrepreneurs, and hurts the very people it intends to help...If the Fed’s seeks to maintain a stable, predictable, and honest price system as its sole monetary policy objective, it will do more to lift people out of poverty than any double or triple mandate.
The implication is that the Fed is currently creating unexpected inflation to lower unemployment. The implication is that the Fed is not meeting its price stability mandate. The first thing that makes this such nonsense is the absolute absence of inflationary pressures for going on 30 years now:

PCE110714

There have been NO episodes of "unexpectedly boosting inflation." In fact, for all intents and purposes, the Phillips Curve has become nonexistent:

PHILLIPS110714

There is no "contradictory tension." The Fed can obviously meet both mandates concurrently. See Minneapolis Federal Reserve President Narayana Kocherlakota. It is pretty straightforward. And even if the Fed wanted to boost inflation beyond its current target, they would not want unexpected inflation. They would only do so because they needed more room to cushion against the zero bound. They would want higher expected inflation. It would be anything but unexpected. They would scream it from sea to sea.
Of course, inflation truthers will argue that the Fed's chosen price measure does not measure "real" inflation. Only "real" people, not economists, know what "real" inflation is. Well, if you ask "real" people, once again you get a flat Phillips Curve:

PHILLIPS2110714

Sure, the public tends to overreact to gas prices (both up and down), but I have always thought the overall consistency of median inflation expectations among the public is pretty remarkable and under-appreciated. To be sure that is arguably because the Fed has generally made reality consistent with expectations. But perhaps not so much lately. Consider inflation expectations and acutal year ahead inflation:

EXPECT110714

Note that I used headline CPI inflation as it is arguably the best known price index. Interestingly, since 1983, average expected inflation was 3.1%, compared to an actual 2.9%. Remarkably close. And note that since 2007, actual inflation over the next twelve months has remained well below expectations. In other words, the US economy is experiencing unexpected disinflation. By the author's argument, shouldn't that mean that unemployment is now artificially high? (Note too that concerns about the Fed's credibility may be premature.)
The second thing that makes this such nonsense is that the authors seem to believe that if the Fed dumped its dual mandate in favor of a single price mandate, monetary policy would be tighter (because the current need to maintain low unemployment requires unexpected inflation, or loose policy). This is exactly opposite of reality. The reality is that if the Fed focused only on its price mandate, it would not be so eager to normalize policy. The Federal Reserve currently can neither hit its target nor anticipates hitting its target over the next two years. So what is driving the push for normalizing policy? They fear that falling unemployment falling toward their estimate of the natural rate (5.2-5.5%) will trigger an inflationary outbreak if not caught early with tighter policy! They want to arrest the decline in unemployment before it slides much below 5.2%.
Truth be told, oftentimes I would prefer the Fed abandon its dual mandate as well. I wish they would focus more on prices than unemployment at this point. But that's because I understand the implications for monetary policy. It would be looser, not tighter. Monetary policymakers would have one less excuse to justify normalizing policy when they still can't hit their inflation targets.
I would also add that the Fed isn't doing itself any favors when they argue that they need to keep policy loose to meet their employment mandate or give the impression that they intend to keep policy loose to address inequality. They could just point out they need to keep policy loose to meet their inflation target and by meeting their inflation target they foster conditions amenable to sustained maximum employment and by extension reducing inequality. Do themselves a favor and keep the price stability mandate front and center. Read Minneapolis Federal Reserve President Narayana Kocherlakota's statement on his dissent:
I felt that the FOMC needed to reduce possible downside risk to the credibility of its 2 percent inflation target by taking more purposeful steps to move inflation back up to 2 percent.
The arch-dove on the FOMC is a dove because his colleagues can't meet or are unwilling to meet their inflation target.
Bottom Line: The Fed is not using unexpected inflation to lower unemployment. Just isn't happening now. Not tomorrow. Or the day after that either. And if the Fed wants to reduce inequality, they don't need unexpected inflation in any event. What they need is to actually generate the inflation they promised.

    Posted by on Friday, November 7, 2014 at 08:05 AM in Economics, Fed Watch, Monetary Policy | Permalink  Comments (61)


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