Fed Fatigue

The Econ blogosphere has erupted over the apparently heinously inconceivable idea that Larry Summers might be the next Fed chair.

Here's Ezra on the situation:

As far as I can tell, there’s almost no one in the economics blogosphere who wants to see Larry Summers named as Ben Bernanke’s replacement. The bulk of opinion ranges from relative indifference between the two candidates (“as we know there’s no real daylight between Yellen and Summers“) to extremely strong anti-Summers opinions (“Larry Summers will destroy the economy“) — with much of the latter being driven by Summers’s record on financial regulation. Tyler Cowen is almost alone in holding up the pro-Summers end of the argument.

Personally, I'm a Bernanke guy. I think he did an amazing job in the height of the crisis and would love to see him take another term. But I'd be fine with Larry Summers (I'm sure Larry is breathing a sigh of relief now that he knows) as Chair. I'd be fine with Yellen too, though I worry that she thinks the Fed can do more than it actually can (at least such a belief is not likely to be very harmful in the near term at least).

But, all the commotion about who's going to be the next Chair is way overblown. It's just not that important, for two reasons. First, the Fed is not independent of politics and without big political change there is not going to be big monetary policy change. Second, the ability of monetary policy to reliably guide the real economy is much more limited than most people want to believe.

On the Fed and politics, you can start here, or here.

As a quick example, consider the "Volcker disinflation" in the early 1980s. Big Paul took office in 1979 and announced in October that the Fed would focus on monetary aggregates and lower their growth rates. However, the actual policy of lower money growth didn't happen until after the election in 1980, which installed a conservative Republican president and a Republican majority in the Senate. In the year between the announcement and the election, monetary growth was unchanged from the previous two years. In the year after the election, monetary growth was only half as fast.

On the limited power of monetary policy to control the real economy, you can start with Adam Posen's recent review essay. Here's a good bit:

Indeed, central bankers should be far humbler today than they were in recent decades, when some claimed credit for the so-called great moderation, the period of reduced economic volatility that lasted from the late 1980s to the early years of this century. It is now clear that the prosperity and stability much of the world enjoyed during those years were largely the result of good luck.

In my view, Posen, if anything is overstating the power of monetary policy over the real economy.

Consider post 2007 US monetary history. The Fed promptly took the policy rate to zero. We still had big problems. So the Fed started QE. We still had big problems. So the Fed did further rounds. We still had big problems. So the Fed tried forward guidance. We still had big problems. So the Fed tried outcome-based as opposed to calendar-based forward guidance. Guess what? We still have big problems (I know, counterfactuals are a b**ch, but the Fed clearly didn't fix things).

You may say, "but recoveries after financial crises are always slow". But people, that's just another way of saying that Central Banking is not that powerful when it's most needed!

You may say, "but they should have done more and that would have fixed things".

That's borderline epistemic closure. "The right monetary policy can do anything. The economy is not fixed, so the right monetary policy was not employed", is going to be pretty hard to ever disprove.

I think some of the Summers backlash is because Larry understands that the power of monetary policy for the real economy is rather limited.

Turning Japanese

This is cross-posted from Cherokee Gothic:

In a widely praised speech, Christina Romer referred to the "regime change" at the Central Bank of Japan as, "one of the most exciting developments in monetary policymaking since the 1930s." She compares recent Japanese policy favorably to recent Fed policy, saying that based on the lesson of 1933, a regime change that raises inflation expectations is needed to break out of the zero-bound / liquidity trap.

Could a Japanese style regime change happen in the USA? Should it? It's important to note (as Romer does),  that the change in Japan was political and electoral.

Shinzo Abe ran on a platform of getting Japan growing and getting out of deflation. He threatened the Bank of Japan. The Head of the Bank ultimately resigned and Abe got his guy, Kuroda, in there with an aggressively expansionary policy brief.

 So the answer to could this happen in the USA I think is no.

 Can you imagine the reaction if a Presidential candidate threatened the Fed Chair (phone call for Rick Perry)? Can you imagine the reaction if Presidential pressure forced Bernanke to resign? Can you imagine the Senate confirmation hearings on Paul Krugman's candidacy for Fed Chair? Can you imagine what the FOMC meetings and votes would be like when Richard Fisher and Charles Plosser butted heads with Chairman Krugman?

 We don't have a parliamentary system of government, we do have a now quite strong norm of no overt, heavy handed political pressure on the Fed, and the Fed chair is not a monetary policy dictator. In principle, the Chair has one vote on a 12 person voting committee.

 Now the question of should this happen in the USA is trickier.

 On the affirmative side, we still have a big output gap, an unacceptably high unemployment rate, too few people in the labor force, and some theoretical evidence that the "expectations channel" could work.

 On the negative side, there isn't much empirical evidence that such a regime change actually will work. The jury hasn't even been selected yet in the Japanese case, so we have one case, the US in 1933, which is not uncontroversial. I mean, the US economy was in terrible shape well after 1933. Unemployment in 1938 was 19% (yes I know about the "mistake of 1937"and all but the point is that the monetary regime change was not decisive in sustainably fixing the US economy).

 Roosevelt took us off gold. That was bold. What would be a comparable present day analog? What if we adopted the Venezuelan Strong Bolivar as our currency. That might work!

Progress at the Fed

I am a forward guidance skeptic. At heart, I'm an "expectations channel" skeptic. But, if the Fed is going to give forward guidance, having it be based on benchmarks rather than the calendar seems clearly better to me.

The idea is rather than saying, "rates at zero til 2015", to say "rates at zero til unemployment falls to X% or inflation rises to Y%".

Of course, picking X and Y is not an easy task. Bernanke might think X=7 and Y=2.5, while Krugman might be more of an X=4 and Y=10 kind of guy.

Charles Evans is given credit for pushing this path, and Janet Yellen, the Fed vice chair seems to be a recent convert.

Obama's re-election gives the Fed a lot more breathing room to experiment with these non-traditional policies, so I give Yellen political astuteness points for holding her fire until after the election.

I still don't see benchmark forward guidance as anything remotely resembling an effective medicine to cure the economy, but it is a better form of guidance than calendar guidance, even though all the caveats about time consistency, binding future Feds, and political pressure still apply equally.

 

Does the Fed think QEIII will produce higher inflation?

The short answer is, not really.

The longer answer can be found in these charts which were released on September 13th, the same day that QEIII was announced:

(you can clic for a slightly better image or refer to page two of the linked PDF)

The bottom panel shows that no one on the FOMC is predicting a surge in inflation from QEIII. The highest individual prediction in 2014 is 2.2% and in 2015 it's 2.3%. The "central tendencies" for those years are 1.8% - 2% in 2014 and 1.9% - 2% in 2015. You can read these numbers from the first table in the link provided above.

I just don't see that the Fed views their language in the QEIII statement or the minutes as seriously committing to higher than equilibrium (i.e. 2%) inflation in the future.

The FOMC is bullish on growth in 2014 and 2015 as can be seen from the top panel of the embedded chart, with a "central tendency" of their forecasts reported as 3.2% - 3.8%. Their long run forecast central tendency is 2.2% - 3%.

There is nothing in these forecasts that indicates the Fed expects NGDP to get back on anything resembling its pre-crash trend.

People, believe me when I tell you that I want the economy to recover. I want lots of new jobs created. I want there to be good times in America for all.

But I think people are projecting their own views onto Fed actions. The FOMC  just isn't playing the game that the Woodfordians want them to play.

 It's my view that it is impossible for the Fed to play and win the Woodfordian game, but I'd love to be proven wrong.

Calvo, we have a problem

We are operating in an era where the Fed is using forward guidance to condition the public's expectation of future interest rates.  Having already pushed the policy rate to zero, the Fed is now left with promising to keep it there in future periods.

An obvious question is, does this work? Or, in what class of models does this work?

 From this recent Cleveland Fed working paper, it seems like part of the answer is, not in the basic DSGE models everyone uses.

 I'll let the authors tell you themselves:

 Our experiments consider a fully anticipated and unconditional lowering of the monetary policy rate for a finite number of periods. We find that the workhorse Calvo (1983) models of time dependent pricing currently used for monetary policy analysis deliver unreasonably large responses of inflation and output in response to such a policy. Furthermore, if there are endogenous state variables, these models suggest that the initial responses can become arbitrarily large as the duration of the fixed rate regime approaches some critical value and then switch sign and become arbitrarily negative as this critical value is exceeded slightly. For empirically realistic models such as the Smets and Wouters (2007) model, the critical duration for which these asymptotes occur is around eight quarters - well within the duration of the low interest rate environment in the U.S. following the financial crisis. 

So, either the promise is not credible, the models are wrong, or maybe both?

Let's be clear that is paper is not done by hacks. One of the authors is Tim Fuerst, and he is the real deal.

What the Fudge?

ADP reports that job growth slows in September: Yglesias says it shows that QE3 is already working!

People, I am not making this up.

Here's the deal: Today, ADP reported 162,000 new jobs for September. It also reported that August's number had been revised to 189,000. Thus we have 27,000 fewer new jobs in September than in August.

Matt then posted this:

the ADP report out this morning says there was a net gain of 162,000 jobs in September (PDF). Now that's all preliminary and maybe it won't hold up. But this—rather than long and variable lags—is what I'd expect to see from QE 3.


Wow. And I thought I was a QE bear!

Now Matt's overall point is that when (if) the Fed is playing the expectations game, we might expect to see things change quickly if they are successful rather than having to wait for a mechanical chain of events to slowly unwind over time.

I even agree that what our economy needs now is a jump from what Tyler calls the "low trust" state to a "high trust" state and that maybe Fed jawboning can help us make that jump.

But I have to question pointing to a slower rate of job growth as evidence that we are jumping.

For what purpose does the gentleman from Oklahoma rise?

I rise to revise and extend my remarks

The gentleman is recognized for one more blog post.


So let me try this again.

Nominal GDP growth is a sum (sort of) of two things. Real Growth and Inflation. Both are outcomes. The two things are not highly correlated with each other. One of them we like and one of them we (usually) don't like.

MMTers (NGDPists) frequently show graphs where a decline in output is correlated with a decline in NGDP and exclaim something like, AHA! THE FED HAS CAUSED THIS DECLINE BY NOT KEEPING NGDP GROWING FAST ENOUGH.

As I was pointing out yesterday, that can be a very tricky case to make because the decline in output is baked directly into the decline in NGDP!

That's what I thought (and still think) Mr. Avent was doing yesterday. But I don't think I actually called him an idiot as he seems to think I did though.

But then again I am so dense that I fail to understand exactly how the Fed is supposed to precisely target NGDP. They've kept the policy rate at zero for multiple years and promised to keep it there for multiple years more. They have flooded the banking system with reserves. But NGDP has not grown fast enough. Now the Fed has promised to keep the pedal to the metal after the economy has recovered, will that get NGDP growth where the MMTers want it?

In all honesty, the most I've been able to glean from the NGDPers is that the Fed should announce a NGDP path they are going to defend and ......

Create a futures market for NGDP and target its price?

Rely on the reverence people have for Fed announcements and sit back and watch NGDP happily conform to the announcement?

I am also so dense that I simply cannot parse some statements made by the NGDP crowd. Like this one from Scott Sumner:

NGDP is “the real thing,” whereas P and Y are simply data points pulled out of the air by Washington bureaucrats.

The man who implores us to "never reason from a price change" is now informing us that distinguishing between price changes and quantity changes is irrelevant or impossible?

Or this one from Mr. Avent:

Even in tough times, some people get raises. Those people capture some of the growth in nominal incomes, leaving a smaller chunk available to go to new incomes.

That's a real puzzler to this Okie. The raises ARE growth in nominal income, aren't they? Or does the Fed pour nominal income over the economy like cereal and we all scramble to grab our share and eat it before it's gone? Nominal income is not an exogenously imposed constraint on the activities of the private economy. Nominal income is largely created by the actions of the private economy.

I guess I just don't speak MMT very fluently.

the gentleman's time has expired

thank you mr. speaker.

I got the QE blues

Ramesh Ponnuru tells us to stop worrying and love QE3. But Ramesh is not giving you the straight poop!

Ramesh: "Long-term interest rates rose after its announcement".

Me: sure for one day, then they started falling right back again.

Look for yourselves:

Ramesh:  "The (stock) market reaction is a sign that this time loosening was warranted".

Me: Yes, stock prices jumped up that day. But look at the trend in stock prices over the last four years

Since early 09, the stock market has been trending up. It's very close to pre-crash levels in nominal terms. QE announcement effects are a drop in the proverbial bucket and certainly don't prove anything about whether or not QE is going to help the real economy.

Ramesh: "Looser money is boosting stocks because it is raising expectations of economic growth and thus of future profits."

Me: Any evidence or proof to back up that assertion? I see no way for him to show this cause and effect.

Do read the whole article. It's really quite bad.

************UPDATE********************

The always relevant Soberlook has more information here.

Take the long way home

A fair amount of the Fed's post-crisis "unconventional policies" have been aimed at the housing market. QEIII in particular. Often, these policies are evaluated on a very short term basis. Before and after the announcement like a pseudo event study is one popular method. Looking at what happens to rates after the policy ends is another. We've all seen charts of the last five years with vertical lines indicating the beginnings and ends of various Fed policies, with credit or blame assessed as desired.

But the basic fact about mortgage rates in this country is that they've been secularly falling. Here's a graph of the average 30 year fixed rate. Data are from Fred.

(clic the pic for an even more ski-slope image)

Rates are less than half what they were in 1976 when this data series begins. Rates have been steadily falling since 1982.

In other words, we've seen a steadily falling trend in mortgage rates over the last 30 years with a fair amount of short run noise around the trend.

Given that context, I think we are putting way too much emphasis on very short run movements in mortgage rates as an indicator of the effectiveness of particular Fed policies or announcements.

I also think, given mortgage rates are already at a 35 year low, that driving them down even more is not going to be a big boon to the housing market. I don't see how it helps re-financers all that much either. If you refinanced at 3.75 are you going to do it again at 3.49?



PS: Do I think the modern Fed deserves credit overall for this falling trend? Sure, just as much as they deserve blame for the ultra-high rates in the late 70s and early 80s.

Fed announcements as "cheap talk"

As any semi-loyal KPC reader knows, I find the "just do your job" critique of the Fed baffling. In our current institutional framework, the Fed cannot credibly commit to future actions that will conflict with their period by period utility function.

That is to say (more or less accurately), the Fed cannot credibly promise to tolerate higher inflation than it prefers after the economy recovers because, when the economy recovers the Fed will still not like inflation and there is nothing to prevent them from not tolerating it. Knowing this, people will not believe the initial announcement.

So, why does the Fed make announcements about the future at all? Could they ever "work".

I believe the relevant economic theory here is the literature on "cheap talk" in games.  A readable approach can be found in Ferrell & Rabin.

For cheap talk to be effective, Ferrell & Rabin argue that it must be self-signalling meaning that the sender only wants to send the message if it is true (or if it is at least correlated with the truth). They also argue that it must be self-committing, meaning if the receiver believes the message, the sender has incentives to fulfill it.

I think that the messages people want the Fed to send are not self-committing, so that such "cheap talk" won't work.

However, there is a famous paper by Jeremy Stein on cheap talk and the Fed that argues that the Fed can make imprecise announcements which will have some effect on expectations. I haven't fully figured that paper out yet.

The Devil is in the Details

Monetary economics superstar M. Woodford has made a big splash with his 97 page opus belittling the Fed's QE moves and calling for (more or less) NGDP targeting.

Here's Krugman on the paper.

There are three big problems with Woodford's approach. (1)The macro model he uses to produce his results, (2) his assumption that the Fed can commit to anything not in their period by period best interest, and (3) the way he completely ignores real political constraints faced by the Fed.

Let's talk about each of these.

The Model:

 It is laid out in Eggertsson & Woodford (2003).

First off, here are a few quotes from the paper:

For simplicity we shall assume complete financial markets and no limits on borrowing against future income.

Our model abstracts from endogenous variations in the capital stock, and assumes perfectly flexible wages (or some other mechanism for efficient labor contracting), but assumes monopolistic competition in goods markets, and sticky prices that are adjusted at random intervals in the way assumed by Calvo (1983), so that deflation has real effects. We assume a model in which the representative household seeks to maximize a utility function

Real balances are included in the utility function, following Sidrauski (1967) and Brock (1974, 1975), as a proxy for the services that money balances provide in facilitating transactions. 

 The paper presents no evidence that the model is consistent with the data, no evidence that it is capable of producing the kind of economic situation in which we currently labor, no evidence that it has any kind of forecasting power.

All conclusions about policy drawn by Woodford are contingent on the maintained assumption that the underlying model of the economy is correct. And we know that it decidedly is not!

Can the Fed commit?

I am a broken record on this subject, but in its current configuration, there is no way the Fed can credibly commit to an optimal but time-inconsistent policy.  The forward guidance / NGDP targeting solutions require the public to believe that the Fed will continue to tolerate inflation higher than they would like AFTER THE ECONOMY RECOVERS. Krugman put it best when he said the Fed must credibly commit to behave irresponsibly!  They can't because there is no mechanism that forces them to deliver the policy after the economy actually recovers.

All we can ever hope for from the Fed in its current configuration are time-consistent polices. Woodford's is not.

Here's Krugman again, giving a not technically correct but yet informative explanation of the problem:

What Mike demonstrates is the point that liquidity-trap worriers have been making for a long time – actually, ever since my 1998 piece. Current monetary policy is indeed ineffective in a liquidity trap; but there is still scope for central bank action in the form of credible commitments to keep monetary policy easy in the future, when the economy is no longer at the zero lower bound. The trouble is how to make those credible commitments. 

Actually, it’s a two-stage problem. First you have to convince the central bank itself that it’s a good idea to signal that you won’t return to normal policy (say a standard Taylor rule) as soon as the economy lifts off from the liquidity trap; then you have to convince the private sector that the central bank will not, in fact, just revert to type once the crisis is past.

There's even a third problem. There's no way to convince the private sector that the Fed won't simply revert to type because when the time comes, the Fed will have no incentive not to revert to type!

What about Politics?

Suppose by some amazing coincidence that Woodford's policy conclusions would also follow from the true model of the economy. Suppose also that we can just dismiss all the literature on time inconsistency by commanding the Fed to "just do its job". We still have the problem that the Fed is not independent of politics.

Romney has already said he wouldn't re-appoint Bernanke. There's at least a .4 chance he'll be President. What hope would a Fed have of running a loose policy after the economy recovers in an all Republican government?

The Republicans control the House now. The Republican party seems to be flirting with a return to the Gold Standard! And the Fed is gonna announce, oh, we're gonna keep rates at zero even after the economy recovers?

The Fed has bosses. A sizable fraction of those bosses will never sign off on the kind of polices Woodford advocates. They would be doing so for the wrong reasons, but those ignorant gold-bug bosses would actually be extremely likely to be right.

Words of wisdom from Jim Hamilton

In a very nice post at Econbrowser, Jim describes Fed actions over the last 5 years and ends with this:

"My view is that the Fed never had the power, and lacks the power today, to solve our primary economic problems. However I believe it did have the power, and successfully exercised the power, to prevent our problems from becoming even worse."

That, in my view, is pretty much exactly right.

Aaargh! Monetary policy is not "tight"

It is certainly true that the nominal interest rate is not a sufficient statistic for the stance of monetary policy, but a low interest rate is NOT somehow prima facia evidence of tight policy!

Let's take an example of how the nominal rate alone is not enough to infer the stance of policy.  If the interest rate is 10% and inflation is running at 20%, the real interest rate is -10% and policy is not tight. If that same 10% interest rate is paired with a 0% inflation rate, then policy would be very tight indeed (real rate of 10%).

So the nominal rate does not in general accurately guide us to a conclusion about monetary policy.

But now consider our current situation. Inflation is around 2%. The Fed has pushed short term rates to around zero. The short term real rate is negative. 10 year government bonds are yielding around 1.6%, so that 10 year rate is slightly negative. According to the email spam I constantly get, 30 year mortgage rates are something like 3.5%, so the real cost of funds to buy a house is 1.5%. That's not negative, but it is low.

Real interest rates that are negative to very low = monetary policy is not tight!

Could monetary policy be even looser? Maybe.

Would it help? Maybe.

If by QE3 the Fed could get mortgage rates down 50 basis points without raising inflation, making the real cost of funds to buy a house fall to 1% would that solve our economic problems? If the Fed could raise inflation expectations to 3% while somehow keeping nominal rates where they are, would that solve our economic problems?

As LeBron pointed out, the costs of trying and failing don't seem to be so high, so why not give it a try? Just don't expect too much.

And please stop railing about tight monetary policy in the US.

Gimme back my bullets

The Fed fired its bullet. The bear wasn't scared. And the bullets may be blanks, anyway. But the point is that there is no secret gun. Or so says Sy Harding...

How to be your own worst enemy

Ben Bernanke is his own worst enemy these days. He keeps insisting that the Fed is not out of ammunition and can do more to strengthen the economy, but to date, has not actually done anything "new" or "more".

Which leads to his ritual excoriation in the blogo/twitter-sphere.

And rightly so.

4 years on, we still have not reached pre-crisis employment levels.  High inflation is not on the immediate horizon, and growth and growth forecasts keep falling. If you can "do more", it's beyond time to walk the walk, not just talk the talk.

Ben Bernanke is an excellent economist and a smart man. So what is going on?

Continue reading below the fold

The ZLB is floor not a ceiling

Again and again I see the economy's problem described along these lines:

"At the ZLB (zero lower bound), the real interest rate is too high to get us to the optimum. The nominal interest rate cannot fall any further by definition. So to get to the optimum the expected rate of inflation must rise."

Those are Simon Wren-Lewis' words (they appear in a comment at the link), but Krugman and many others tell roughly the same story.

As always, I have questions.

In the IS/LM framework many (not Wren-Lewis) are using, doesn't this mean that we are getting "growth" by firms investing in projects with a negative NPV now made profitable by an even more negative discount rate?

Second, how is that inflation expectations rise and the nominal interest rate remains unchanged?

From Fisher, we think of the nominal rate as the required real rate of return plus a premium to offset expected inflation. So it's hard for me at least to think about expected inflation doubling (from 1.5 to 3 percent) or tripling (from 1.5 to 4.5 percent) without the nominal rate rising. For that to happen the required real return would have to fall one for one with the rise in expected inflation.

In other words, the ZLB is a floor, but not a ceiling.

Is the upcoming election holding the Fed back?

The US economy is going nowhere fast. Growth is low, unemployment is high and inflation (core and headline) are falling below 2%, re-kindling worries about deflation.

But the Fed is sitting pat. Sure they've done a lot in my view. Dropped rates to zero, promised to keep them there a while, pumped trillions of reserves into the system, ran a couple rounds of quantitative easing and don't forget about "operation twist". Nor do I have much confidence that, at this point in the proceedings, monetary policy is capable of a miracle cure for the economy.

But holy spumoli people, don't they have to do something? Sure they do; they're the Fed, dammit!

Bernanke can't keep saying that the Fed is not out of ammo but never fire the gun. The Wolfersons are KILLING him!

Could it be possible that the Fed does not want to be seen "goosing" the economy in the run-up to the Presidential election?

Might the Fed be guarding its vaunted "independence" by avoiding any actions that could be considered politically motivated?

Will we see QE3 or a higher inflation target on the first Wednesday in November?

I think this has to be a factor in the Fed's decision about the timing of further action. Things may worsen enough for them to feel they have to act no matter what, but I think they may be trying to muddle through with the status quo until after the election.

Tell me why I'm wrong in the comments.

Another sh*&^y jobs report

Wow. 80,000 net new jobs in June. The last three months (after revisions) now come out to 68,000 - 77,000 - 80,000 and that "trend" is not going to help anyone anytime soon. As Mungo noted, job growth needs to almost triple for unemployment to significantly fall.

People, an infrastructure bank is not going to fix this. QE III is not going to fix this. Retroactive NGDP level targeting is not going to fix this. Tax increases are not going to fix this.

This morning Twitter is again ablaze with calls for the Fed to "finally" act.

Remember this is a Fed that has already kept its policy rate at nearly zero for multiple years and promised to do so until late 2014. A Fed that has vastly expanded its balance sheet pumping trillions of new reserves into the system. A Fed that has already engaged in a couple rounds of quantitative easing.

I believe that at the core of the calls for the Fed to act is a desire for higher inflation. Sure, that's fine with me, lets give it a try. But I don't think running inflation at say 4% is going to be a magic bullet.

Are there still nominal contracts that haven't yet been expired, adjusted or abrogated 4 years into this mess?

Can inflation double and nominal interest rates stick at their current rates? Will the Fisher effect really be neutered?

Even if real rates become a bit negative, will firms really start to make massive investments in projects they would expect to be unprofitable when discounted at zero percent or one percent?

When people call for the Fed to finally act or accuse Bernanke of dereliction of duty ask them this question:  What can the Fed do that will fix this mess, how exactly would the policy action be implemented and by what mechanism would it effect the cure?

And if their answer is that merely adopting a new policy target will cause an expectational change that fixes the mess?

RUN!!!

Promises, Promises

Yesterday, Slate's Matt Yglesias tweeted,

"If Bernanke ended the recession tomorrow, it would be an admission that he could have ended it two years ago. So he won't."

Let's break it down, KPC style:

1. Matt, the recession is over. The NBER dates the business cycle and puts the end of the recession as June 2009!  Matt is not the only one doing this, but it is misleading and quite incorrect to do so.

2. For argument's sake, let's replace "ended the recession" with "accelerated growth". Then the conditional statement would be true. If BB could instantly accelerate growth tomorrow, he also could have done it two years ago.

3. Consider all the things BB has done to try and accelerate growth. Short term rates at zero. Promising to keep short term rates at zero for years (until late 2014). Pumping reserves into the system at an historically unprecedented rate. Two rounds of quantitative easing.

4. Matt doesn't say how BB could accelerate growth tomorrow (he only had 140 characters). I assume Matt means that BB could make a policy announcement that would instantly change everything. Something like a retroactive commitment to an nominal GDP path or a retroactive commitment to a price level path. If that's not what Matt means, then I apologize and withdraw what follows below.

5. The key for policies like that to work, even in theory, is that BB must, in Paul Krugman's words, "credibly promise to be irresponsible" and I see no way for the Fed to do so in general, let alone in this political environment. It's a lot harder than it might seem (to get an idea of how hard, check out Svensson's "foolproof way" paper).

6. I too am unhappy with the current state of the US economy. Growth is too slow and unemployment is too high. But it simply is not in the power of any single person in the world to change that in a day. Implying that BB is deliberately keeping the US economy down does not serve any constructive purpose.

Bank Runs: To Save MMM Funds, Scrap Them

KPC Pal Amar Bhide has an interesting piece in Bloomberg.

In an email, Amar asks:   The just published piece implicitly offers another route to universal -- and explicit -- deposit guarantees.  My European friends: Might a similar "ECB Direct" accounts be the answer to bank runs in Spain etc?