Close

This page had been redirected to a new URL, please update any bookmarks.

Font Size: A A A

macroblog

May 13, 2013

Labor Force Participation and the Unemployment Threshold

On Friday, my colleague Julie Hotchkiss shared in this space the results of her new research (with Fernando Rios-Avila, a Georgia State University colleague) on the recent and prospective behavior of the labor force participation rate (LFPR). The punch line, from my point of view, is this:

Our results suggest that relative to the average LFPR over the years 2010–12, the average LFPR over the years 2015–17 will rise by about a third of a percentage point—again, if the labor market returns to prerecession conditions. (Italics original)

As Julie notes:

[T]he Federal Open Market Committee has substantially raised the stakes on disentangling...movements in labor force participation...by introducing into its policy deliberations concepts like unemployment thresholds and qualitative assessments on "substantial" labor market improvement.

Though the meaning of "substantial labor market improvement"—a condition for adjusting the FOMC's current large-scale asset purchase program—is somewhat ambiguous, the unemployment threshold for considering moving the federal funds rate off the near-zero mark is less so. As the Committee indicated in its May press release:

[T]he Committee decided to keep the target range for the federal funds rate at 0 to ¼ percent and currently anticipates that this exceptionally low range for the federal funds rate will be appropriate at least as long as the unemployment rate remains above 6½ percent, inflation between one and two years ahead is projected to be no more than a half percentage point above the Committee's 2 percent longer-run goal, and longer-term inflation expectations continue to be well anchored.

It is widely understood (a sign of the times, no doubt) that changes in the unemployment rate are not entirely independent of what is happening with the participation rate. We have discussed this issue before here in macroblog. But in light of the new research coming from our own shop (and other research cited in Julie's post), it seems like a good time for a refresher.

First, a step back. Multiple upward revisions to the employment situation since the December jobs report—you can follow the trail courtesy of Calculated Risk here, here, here, here, and here—have led to a more robust picture of the labor market than certainly I was thinking. Here is what the record looks like for most of the recovery:

With an assist from the Atlanta Fed Jobs Calculator, we can provide further perspective on these numbers. In particular, under the assumption that the labor force participation rate will remain at its current level of 63.3 percent (among other things held constant), we can map the recent job growth numbers to a rough date when the unemployment rate will reach 6½ percent.

That looks interesting, but then taking the Hotchkiss and Rios-Avila research onboard means the assumption of a constant labor force participation rate may not be justified. So, turning again to the Jobs Calculator, the following table answers this question: If we continue on the 208,000-per-month pace of job creation of the last six months, and the labor force participation rate is X, what would the unemployment rate be by June of next year? For reference, the first row of the table replicates the earlier result under the assumption that the participation rate will maintain its current level; the second row takes into account the Hotchkiss and Rios-Avila research; and the third assumes an even larger bounce back in participation:

It is probably worth noting that the full increase in the Hotchkiss and Rios-Avila estimates happens in the 2015–17 timeframe, raising the interesting possibility that the threshold for considering interest rate increases could occur sometime before the unemployment rate moves back above the threshold.

Also, it is not at all obvious that rising labor force participation would necessarily arrive along with a rising unemployment rate. From 1996 through 1999, for example, the participation rate rose by nearly by 0.7 percentage point (the difference between the rates in the first and third rows in the table above), even as the unemployment rate fell by just over 1½ percentage points. The key was the strong employment growth over that period—almost 260,000 payroll jobs per month on average.

All of that, as should be clear by now, embeds a whole bunch of assumptions, which may make this the most important part of the FOMC's decision criteria:

In determining how long to maintain a highly accommodative stance of monetary policy, the Committee will also consider other information, including additional measures of labor market conditions...

Photo of Dave AltigBy Dave Altig, executive vice president and research director of the Atlanta Fed

May 13, 2013 in Employment, Labor Markets, Monetary Policy | Permalink

TrackBack

TrackBack URL for this entry:
http://www.typepad.com/services/trackback/6a00d8341c834f53ef01901c221420970b

Listed below are links to blogs that reference Labor Force Participation and the Unemployment Threshold:

Comments

Post a comment

Comments are moderated and will not appear until the moderator has approved them.

If you have a TypeKey or TypePad account, please Sign in

March 08, 2013

Will the Next Exit from Monetary Stimulus Really Be Different from the Last?

Suppose you run a manufacturing business—let's say, for example, widgets. Your customers are loyal and steady, but you are never completely certain when they are going to show up asking you to satisfy their widget desires.

Given this uncertainty, you consider two different strategies to meet the needs of your customers. One option is to produce a large quantity of widgets at once, store the product in your warehouse, and when a customer calls, pull the widgets out of inventory as required.

A second option is to simply wait until buyers arrive at your door and produce widgets on demand, which you can do instantaneously and in as large a quantity as you like.

Thinking only about whether you can meet customer demand when it presents itself, these two options are basically identical. In the first case you have a large inventory to support your sales. In the second case you have a large—in fact, infinitely large—"shadow" inventory that you can bring into existence in lockstep with demand.

I invite you to think about this example as you contemplate this familiar graph of the Federal Reserve's balance sheet:

130307

I gather that a good measure of concern about the size of the Fed's (still growing) balance sheet comes from the notion that there is more inherent inflation risk with bank reserves that exceed $1.5 trillion than there would be with reserves somewhere in the neighborhood of $10 billion (which would be the ballpark value for the pre-crisis level of reserves).

I understand this concern, but I don't believe that it is entirely warranted. My argument is as follows: The policy strategy for tightening policy (or exiting stimulus) when the banking system is flush with reserves is equivalent to the strategy when the banking system has low (or even zero) reserves in the same way that the two strategies for meeting customer demand that I offered at the outset of this post are equivalent.

Here's why. Suppose, just for example, that bank reserves are literally zero and the Federal Open Market Committee (FOMC) has set a federal funds rate target of, say, 3 percent. Despite the fact that bank reserves are zero there is a real sense in which the potential size of the balance sheet—the shadow balance sheet, if you will—is very large.

The reason is that when the FOMC sets a target for the federal funds rate, it is sending very specific instructions to the folks from the Open Market Desk at the New York Fed, who run monetary policy operations on behalf of the FOMC. Those instructions are really pretty simple: If you have to inject more bank reserves (and hence expand the size of the Fed's balance sheet) to maintain the FOMC's funds rate target, do it.

To make sense of that statement, it is helpful to remember that the federal funds rate is an overnight interest rate that is determined by the supply and demand for bank reserves. Simplifying just a bit, the demand for reserves comes from the banking system, and the supply comes from the Fed. As in any supply and demand story, if demand goes up, so does the "price"—in this case, the federal funds rate.

In our hypothetical example, the Open Market Desk has been instructed not to let the federal funds rate deviate from 3 percent—at least not for very long. With such instructions, there is really only one thing to do in the case that demand from the banking system increases—create more reserves.

To put it in the terms of the business example I started out with, in setting a funds rate target the FOMC is giving the Open Market Desk the following marching orders: If customers show up, step up the production and meet the demand. The Fed's balance sheet in this case will automatically expand to meet bank reserve demand, just as the businessperson's inventory would expand to support the demand for widgets. As with the businessperson in my example, there is little difference between holding a large tangible inventory and standing ready to supply on demand from a shadow inventory.

Though the analogy is not completely perfect—in the case of the Fed's balance sheet, for example it is the banks and not the business (i.e., the Fed) that hold the inventory—I think the story provides an intuitive way to process the following comments (courtesy of Bloomberg) from Fed Chairman Ben Bernanke, from last week's congressional testimony:

"Raising interest rate on reserves" when the balance sheet is large is the functional equivalent to raising the federal funds rate when the actual balance sheet is not so large, but the potential or shadow balance sheet is. In both cases, the strategy is to induce banks to resist deploying available reserves to expand deposit liabilities and credit. The only difference is that, in the former case, the available reserves are explicit, and in the latter case they are implicit.

The Monetary Policy Report that accompanied the Chairman's testimony contained a fairly thorough summary of costs that might be associated with continued monetary stimulus. Some of these in fact pertain to the size of the Fed's balance sheet. But, as the Chairman notes in the video clip above, when it comes to the mechanics of exiting from policy stimulus, the real challenge is the familiar one of knowing when it is time to alter course.

Photo of Dave AltigBy Dave Altig, executive vice president and research director of the Atlanta Fed

 

March 8, 2013 in Banking, Fed Funds Futures, Federal Reserve and Monetary Policy, Monetary Policy | Permalink

TrackBack

TrackBack URL for this entry:
http://www.typepad.com/services/trackback/6a00d8341c834f53ef017d41937c63970c

Listed below are links to blogs that reference Will the Next Exit from Monetary Stimulus Really Be Different from the Last?:

Comments

One potential risk this time is that the Fed has been buying lots of assets that aren't treasuries, and some of the riskier assets can no longer be sold for the same price at which it was bought. In theory that situation could leave the Fed unable to recall all the money it put into circulation.

That said, you are right that interest on reserves could still be raised to have the same effects.

Posted by: Matthew Martin | March 08, 2013 at 03:30 PM

"In both cases, the strategy is to induce banks to resist deploying available reserves to expand deposit liabilities and credit."

Banks cannot lend their reserves. In fact, there is no balance sheet transaction that will allow a central bank liability to be loaned to a "non-bank" entity. Banks make loans by issuing a demand deposit and not by issuing reserves. Bank lending is never constrained by a reserve position.

The IoER policy implemented in 2008 moved the Federal Reserve out of a "corridor system" and into a "floor system". Under a floor system the level of reserves and the overnight interest rate are divorced. The IoER or "floor level" also becomes the deposit level. This disconnect works as long as there are sufficient excess reserves within the system, which in the case of the US, there are adequate excess reserves.

It should also be noted that future increases in the overnight rate are simply announced with the lending and deposit rates changing in tandem. Traditional models of draining reserves via FOMO are no longer required. Reserves are not the dual of overnight interest rates. Thus, when the Fed would like to "tighten" policy it will not be required to reduce the size of it's balance sheet as draining operations are no longer required to hit the overnight target.

Posted by: JJTV | March 08, 2013 at 05:58 PM

How about changing how monetary policy is conducted? Instead of using the blocked and saturated credit markets for monetary policy just bypass them and modify the fed so it deals directly with the public.

www.internationalmonetary.wordpress.com

Posted by: Daniel | March 09, 2013 at 12:55 AM

If the fed marks up its long position and passes the gain to the treasury wont it have to pass the loss when it hikes the fed rate? and what will be the impact to treasurys when it hikes the fed rate? wont it raise the cost to the government budget when rates go up and it has to finance the debt at 110% debt to gdp and a duration of less than 5 thanks to the fed? Aren't we underestimating the potential damage to hiking rates?

Posted by: Emilio Lamar | May 01, 2013 at 02:33 PM

Post a comment

Comments are moderated and will not appear until the moderator has approved them.

If you have a TypeKey or TypePad account, please Sign in

March 01, 2013

What the Dual Mandate Looks Like

Sometimes simple, direct points are the most powerful. For me, the simplest and most direct points in Chairman Bernanke’s Senate testimony this week were contained in the following one minute and 49 seconds of video (courtesy of Bloomberg):

At about the 1:26 mark, the Chairman says:

So, our accommodative monetary policy has not really traded off one of [the FOMC’s mandated goals] against the other, and it has supported both real growth and employment and kept inflation close to our target.

To that point, here is a straightforward picture:

Inflation and Unemployment

I concede that past results are no guarantee of future performance. And in his testimony, the Chairman was very clear that prudence dictates vigilance with respect to potential unintended consequences:

Highly accommodative monetary policy also has several potential costs and risks, which the committee is monitoring closely. For example, if further expansion of the Federal Reserve's balance sheet were to undermine public confidence in our ability to exit smoothly from our accommodative policies at the appropriate time, inflation expectations could rise, putting the FOMC's price stability objective at risk...

Another potential cost that the committee takes very seriously is the possibility that very low interest rates, if maintained for a considerable time, could impair financial stability. For example, portfolio managers dissatisfied with low returns may reach for yield by taking on more credit risk, duration risk, or leverage.

Concerns about such developments are fair and, as Mr. Bernanke makes clear, shared by the FOMC. Furthermore, the language around the Fed’s ultimate decision to end or alter the pace of its current open-ended asset-purchase program is explicitly cast in terms of an ongoing cost-benefit analysis. But anyone who wants to convince me that monetary policy actions have been contrary to our dual mandate is going to have to explain to me why that conclusion isn’t contradicted by the chart above.

Photo of Dave AltigBy Dave Altig, executive vice president and research director of the Atlanta Fed

March 1, 2013 in Employment, Federal Reserve and Monetary Policy, Inflation, Monetary Policy | Permalink

TrackBack

TrackBack URL for this entry:
http://www.typepad.com/services/trackback/6a00d8341c834f53ef017ee8d5dec1970d

Listed below are links to blogs that reference What the Dual Mandate Looks Like:

Comments

Post a comment

Comments are moderated and will not appear until the moderator has approved them.

If you have a TypeKey or TypePad account, please Sign in

January 18, 2013

Still a Skeptic: Addressing a Few Questions about Nominal GDP Targeting

In a comment to last week's post on inflation versus price-level targeting, David Beckworth asks the following (referring back to an even earlier post on nominal gross domestic product [NGDP] targeting):

You refer back to your previous post on NGDP level targeting, but fail to take note of the comments that respond to your concerns about it. Specifically, see the ones by Andy Harless and Gregor Bush. Would love to see your response to those ones. Do you have a response for them? I am listening if you have one.

Here is an excerpt from the Harless comment...

Most people who advocate NGDP targeting today advocate level path targeting, not growth rate targeting. I don't believe that your "historical justification" applies in this case. Indeed, I think it makes the case for level targeting (of either the price level or NGDP, but there are reasons to prefer the latter) relative to the current system which centers on a growth rate target for the price level (in other words, an inflation target).

...and here is the Bush comment:

Just to add to Andy's point, advocates of NGDP level targeting argue that it's precisely because of uncertainty around estimates [of] potential output [that] NGDP targeting should be adopted. They argue that [as] long as the central bank keeps nominal spending on, say, a 5% trend line, there will be neither demand side recessions (mass unemployment) nor high inflation. In other words, AD will be stable and this will produce a stable macroeconomic environment. Whether inflation is 2% and real output [grows] at 3% or inflation is 3% and real output grows at 2% is of no concern.

In the post on NGDP targeting I was in fact thinking about level targeting, and Gregor Bush's last sentence gets to—in fact is—the heart of our disagreement. I am just not willing to concede that anchoring long-term inflation by saying something like "2 percent, 3 percent, whatever" is the path to sustaining central bank credibility. Over the longer term, inflation is the only thing that monetary policy can reliably deliver, as the Federal Open Market Committee (FOMC) has clearly articulated in its statement of longer-run goals and policy strategy:

The inflation rate over the longer run is primarily determined by monetary policy, and hence the Committee has the ability to specify a longer-run goal for inflation. The Committee judges that inflation at the rate of 2 percent, as measured by the annual change in the price index for personal consumption expenditures, is most consistent over the longer run with the Federal Reserve's statutory mandate...

The maximum level of employment is largely determined by nonmonetary factors that affect the structure and dynamics of the labor market. These factors may change over time and may not be directly measurable. Consequently, it would not be appropriate to specify a fixed goal for employment; rather, the Committee's policy decisions must be informed by assessments of the maximum level of employment, recognizing that such assessments are necessarily uncertain and subject to revision.

This excerpt does not imply, of course, that the Fed need slavishly pursue a numerical inflation target in the shorter run and, as I have pointed out before, in his last press conference Chairman Bernanke explicitly indicated that the FOMC does not intend to do so:

The Committee... intends to look through purely transitory fluctuations in inflation, such as those induced by short-term variations in the prices of internationally traded commodities, and to focus instead on the underlying inflation trend.

My price-level targeting post, co-authored with Mike Bryan, was exactly making the point that, over the past couple of decades, the FOMC has essentially delivered on a 2 percent longer-term price-level growth objective, while accepting plenty of shorter-term variability.

In the end, it is an open question whether credibility in delivering price stability, hard won in the '80s and early '90s, could be sustained if the FOMC says it does not care so much about the exact level of the average rate of inflation, even in the long run. To be truthful, I can't give you an answer to that question. But neither can the proponents of NGDP targeting. I just don't feel that this is an opportune time for an experiment.

Update: Scott Sumner responds.

Dave AltigBy Dave Altig, executive vice president and research director of the Atlanta Fed

 

January 18, 2013 in Federal Reserve and Monetary Policy, GDP, Monetary Policy | Permalink

TrackBack

TrackBack URL for this entry:
http://www.typepad.com/services/trackback/6a00d8341c834f53ef017c35f88d98970b

Listed below are links to blogs that reference Still a Skeptic: Addressing a Few Questions about Nominal GDP Targeting:

Comments

"I am just not willing to concede that anchoring long-term inflation by saying something like "2 percent, 3 percent, whatever" is the path to sustaining central bank credibility. Over the longer term, inflation is the only thing that monetary policy can reliably deliver, as the Federal Open Market Committee (FOMC) has clearly articulated in its statement of longer-run goals and policy strategy:..."

Presumably the damning part of the FOMC statement is the following portion:

"...The maximum level of employment is largely determined by nonmonetary factors that affect the structure and dynamics of the labor market. These factors may change over time and may not be directly measurable. Consequently, it would not be appropriate to specify a fixed goal for employment; rather, the Committee's policy decisions must be informed by assessments of the maximum level of employment, recognizing that such assessments are necessarily uncertain and subject to revision..."

This might be relevant if nominal GDP (NGDP) level targeting were indeed "specifying a fixed goal for employment." But NGDP level targeting is not specifying a fixed goal for employment. Rather it is specifying a fixed goal for NGDP.

The only thing that the Fed can reliably target are nominal variables, such as inflation and NGDP.

But one very significant problem with targeting inflation is that it is a totally artificial construct requiring that we come up with an estimate of the extraordinary abstraction known as the "aggregate price level." To see how preposterous this is imagine equating the aggregate price level between what it is now and what it was in say 14th century England. The goods and services are so different it requires the complete suspension of one's disbelief.

Inflation is the difference between NGDP and real GDP (RGDP), meaning inflation is nothing more than the estimated residual between a nominal variable, which is relatively straight forward to measure, and a real variable, which is fundamentally an exercise in crude approximation.

In short, this is precisely backwards.

Posted by: Mark A. Sadowski | January 19, 2013 at 12:42 PM

Thanks David,
I appreciate your response. I have to disagree with this statement though:

“I am just not willing to concede that anchoring long-term inflation by saying something like "2 percent, 3 percent, whatever" is the path to sustaining central bank credibility. Over the longer term, inflation is the only thing that monetary policy can reliably deliver, as the Federal Open Market Committee (FOMC) has clearly articulated in its statement of longer-run goals and policy strategy.”

I don’t think that’s correct. It’s true that monetary policy can’t target real variables in the long run. But it can certainly target any nominal variable that it wants to. The Hong Kong Monetary authority has targeted an exchange rate of 7.75 HKD per USD for almost 30 years and it has been completely successful in doing so. Inflation over that period of time has fluctuated substantially, reaching a high of +12% in 1991 to a low of -6% in 1999. Over that 30 year period, Hong Kong inflation has averaged about 1.3 percentage points above US inflation. Does all of this mean that the HKMA has no credibility? Of course not. It has been and continues to be completely credible with respect to the chosen target. Now, we could argue whether Hong Kong might be better severed if it targeted 2% CPI inflation rather than the nominal USD exchange rate (I think it would be). But that’s an argument over which comes closer to the socially optimal target, not over which target would give the central bank more credibility.

We could make a similar argue with the Bank of England successfully targeting the nominal price of gold in the 1871 to the 1914 period. So I see no reason why the Fed couldn’t target nominal GDP and be completely credible with respect to its NGDP target. If Congress instructed the Fed to switch to an NGDP level target would you bet against the FOMC hitting it?

“I just don't feel that this is an opportune time for an experiment.”

Here again, I disagree. I think it’s an excellent time. The only better time would have been January of 2009. The performance of the economy over the past 5 years has been an unmitigated disaster. And the “hard won battles” of the early 1980s and 1990s weren’t enough to prevent it. It turns out that anchoring inflation expectations at 2% is not enough to prevent a massive and sustained shortfall in aggregate demand. In 2007, I thought that a 2% inflation target ruled out the possibility of a recession of this magnitude. But I was wrong.

Posted by: Gregor Bush | January 21, 2013 at 04:56 PM

Thanks David for taking the time to reply. I have been meaning to respond, but as you note Scott already has. I would also encourage you to take a look at Scott's piece in the FT Alphaville where he engages in a similar discussion:

http://ftalphaville.ft.com/2013/01/24/1353932/guest-post-scott-sumner-responds-on-ngdp-level-targeting/

Also, see Bill Woolsey's response to Charles Goodhart's NGDPLT critique:

http://monetaryfreedom-billwoolsey.blogspot.com/2013/01/goodhart-on-ngdplt.html

Posted by: David Beckworth | January 24, 2013 at 10:22 AM

I am fully convinced that the Fed policy and tac is incorrect. 0% interest rates and continuous monetization of the debt through QE is not getting us anywhere.

There are opportunity costs as well.

I realize the fiscal policy which the Fed doesn't control isn't optimum either. But, the Fed ought to let the charade stop.

Posted by: Jeff Carter | January 30, 2013 at 10:13 PM

Post a comment

Comments are moderated and will not appear until the moderator has approved them.

If you have a TypeKey or TypePad account, please Sign in

December 28, 2012

Nominal GDP Targeting: Still a Skeptic

In a few days the clock will run out on another year of disappointing economic growth in the United States and, generally speaking, in the world. It is inevitable and appropriate, then, that the year-end ritual of looking forward by looking backward will include an assessment of whether more or better policy can contribute to a pick-up in growth that failed to materialize in 2012.

To this discussion, Harvard professor Jeff Frankel brings some fresh thinking to the not-quite-fresh notion that the Fed should adopt a nominal gross domestic product (GDP) targeting approach as a replacement for existing central bank practice—described by Frankel and others as policy driven by an inflation-targeting framework. What I particularly like about Frankel's proposal is the fact that he offers up a practical roadmap for using the Fed's current communications tools to transition to an explicit nominal GDP targeting framework. If I were inclined to think such a move would be a good idea, I would view Frankel's proposal with some enthusiasm. Alas, I am not yet so inclined.

As to the case for skepticism on theoretical grounds, I commend to you this excellent post by Mark Thoma at Economist's View. But Professor Frankel suggests a case for nominal GDP targeting on practical grounds by appealing to this counterfactual:

A nominal GDP target for the US Federal Reserve might have avoided the mistake of excessively easy monetary policy during 2004-06, a period when nominal GDP growth exceeded 6 per cent.

Maybe. Average annual real GDP growth over those three years was just over 3 percent, compared to the Congressional Budget Office (CBO) estimates of potential GDP growth of just under 2.5 percent. That's not a big difference, but more importantly the average gap between the level of real GDP and the CBO estimate of potential was just 0.3 percent of average output—essentially zero. The importance of this so-called "output gap" becomes evident if you read the Michael Woodford interview referenced in the aforementioned piece at Economist's View. In that interview, Woodford says, "The idea was to talk about a price level, as opposed to the inflation rate, but a corrected price level target where you add to it some multiple of the real output gap." So for him, something like this measure would be a key element of his proposed monetary policy rule.

What if, rather than some measure of nominal GDP, the 2004–06 Fed had instead been solely focused on the inflation rate? You can't answer that question without operationalizing what it means to be "focused on the inflation rate," but for the sake of argument let's simply consider actual annualized PCE inflation over a two-year horizon. (In his press statement explaining the Federal Open Market Committee's (FOMC) latest decision, Fed Chairman Ben Bernanke suggested using a one- to two-year horizon for inflation forecasting horizon to smooth through purely transitory influences on inflation that the central bank would inclined to "look through.") Here's the record, with the period from 2004 through 2006 highlighted:

121228b

If you really do think that there was a policy mistake over the 2004–06 period—and in particular if you believe the FOMC during that should have adopted a more restrictive policy stance—I'm hard-pressed to see what advantage is offered by focusing on nominal GDP rather than inflation alone. In fact, you could argue that that the GDP part of the nominal GDP target would have added just about nothing to the discussion.

I add the observation in the chart above to my earlier comments on an earlier Frankel call for nominal GDP targets. To summarize my concerns, the Achilles' heel of nominal GDP targeting is that it provides a poor nominal anchor in an environment in which there is great uncertainty about the path of potential real GDP. As I noted in my earlier post, there is historical justification for that concern.

Basically, anyone puzzling through how demographics are affecting labor force participation rates, how technology is changing the dynamics of job creation, or how policy might be altering labor supply should feel some humility about where potential GDP is headed. For me, a lack of confidence in the path of real GDP takes a lot of luster out of the idea of a nominal GDP target.

Dave AltigBy Dave Altig, executive vice president and research director at the Atlanta Fed

 


December 28, 2012 in Federal Reserve and Monetary Policy, GDP, Monetary Policy | Permalink

TrackBack

TrackBack URL for this entry:
http://www.typepad.com/services/trackback/6a00d8341c834f53ef017ee6b9785e970d

Listed below are links to blogs that reference Nominal GDP Targeting: Still a Skeptic:

Comments

I think you're right to be a skeptic on targeting NGDP. Nominal GDP bounced between 5-7% post the 2001 recession. And that's after all the revisions. Maybe more to the point is that the Great Recession occurred, in large part, because of hyper credit growth. It's likely that rates were kept too low for too long, which ultimately pushed the reach for yield process, which enabled the excess debt creation. We won't go into the abdication of the regulatory bodies.....

Posted by: stewart sprague | December 28, 2012 at 06:53 PM

Most people who advocate NGDP targeting today advocate level path targeting, not growth rate targeting. I don't believe that your "historical justification" applies in this case. Indeed, I think it makes the case for level targeting (of either the price level or NGDP, but there are reasons to prefer the latter) relative to the current system which centers on a growth rate target for the price level (in other words, an inflation target).

The question is whether the Fed should forgive itself for missing earlier targets. Under the current system, there is near-100% amnesty, which has the potential to make the nominal anchor ineffective, in the case where the Fed keeps making the same mistake over and over, as it did in the 1970's. A level path target during the 1970's would have forced the Fed to tighten when it missed its targets on the upside, in order to get back to the target path. This is true for either a price level path target or an NGDP level path target.

Of course the downside of using a level path target is pretty obvious: you need to produce "unnecessary" recessions and/or inflations to compensate for earlier misses. But I think the improvement in credibility (particularly when the zero bound comes into play, but also in a situation like the 1970's, where forecast errors were serially correlated) would be worth the cost. And I don't think there's much of a case to be made that price level path targeting is better than NGDP level path targeting, unless the price level is your only mandated objective.

Posted by: Andy Harless | December 28, 2012 at 07:21 PM

"To summarize my concerns, the Achilles' heel of nominal GDP targeting is that it provides a poor nominal anchor in an environment in which there is great uncertainty about the path of potential real GDP."

I think that most people who are blogging in support of NGDP level targeting would be puzzled by this comment. Yes, NGDP level targeting sets the nominal anchor in terms of nominal incomes, not the price level. But most of what are called "welfare costs of inflation" seem to correlate better with variations in nominal incomes than in prices. For instance, "natural" interest rates are better described as correlating with NGDP growth rates than with inflation rates; nominal wages correlate with NGDP rather than the price level.

George Selgin (in "Less than Zero") advances a rather complex argument that because variations in RGDP are generally due to firm- or sector-specific changes, nominal income targeting interacts better with price stickiness and similar imperfections.

In general, resiliency to supply-side instability is generally seen as a key _benefit_ of NGDPLT: and this should be all the more true when the RGDP path is uncertain.

Anyway, Sumner has come up with a 'compromise' proposal (dubbed a NGDP/inflation hybrid) which aims to stabilize NGDP in the short/medium run while still keeping a stable inflation target in the longer run: see www.themoneyillusion.com/?p=18145

Posted by: anon | December 29, 2012 at 10:13 PM

What matters for monetary policy is how it affects expectations. In that context, you're either missing or ignoring a couple of things about the Market Monetarist position.

First, a level target rather than a growth rate target really matters. The former is equivalent to the latter but with the additional assurance that misses will be made up for. That assurance means that over all but the shortest runs, the implicit growth rate target will be hit. That can only help when expectations are your real target.

In the Thoma post you link to, Woodford also points out that as a pratical matter, an NGPD level target is about the best the Fed can do. A policy rule has to (i) be simple enough that you can explain it to Congress and the public, and (ii) be straightforward enough that it doesn't arouse suspicions that the Fed is cooking the books. We have enough conspiracy theorists out there already. Let's not feed them even more by employing a target that looks like the Fed could be manipulating it via arcane calculations.

As you say, we don't know the future path of potential output. But that's hardly an excuse to add to the uncertainty by refusing to adopt clear and predictable Fed policies.

Posted by: Jeff | December 30, 2012 at 08:02 AM

Isn't there a point at which the policy stance should be to stop intervening in markets, to let the free market determine interest rates like any other price, and for the Fed to stop targeting ANYTHING? Why are we even entertaining never ending central planning as a solution to anything?

Posted by: Chris | January 01, 2013 at 09:49 PM

Isn't there a point at which the policy stance should be to stop intervening in markets, to let the free market determine interest rates like any other price, and for the Fed to stop targeting ANYTHING? Why are we even entertaining never ending central planning as a solution to anything?

Posted by: Chris | January 01, 2013 at 09:49 PM

David,
Just to add to Andy's point, advocates of NGDP level targeting argue that it's precisely becasue of uncertainty around estiamtes potential output is NGDP trageting should be adopted. They argue that has long as the central bank keeps nominal spending on, say, a 5% trend line, there will be niether demand side recessions (mass unemployment) nor high inflation. In other words AD will be stable and this will produce a stable macroeconomic environment. Whether inflation is 2% and real output growth at 3% or inflation is 3% and real output grows at 2% is of no concern.

Posted by: Gregor Bush | January 04, 2013 at 02:13 PM

Anybody here ever heard of Goodhart's Law?

Posted by: Thomas Esmond Knox | January 13, 2013 at 11:54 PM

Most people who advocate NGDP targeting today advocate level path targeting, not growth rate targeting

Posted by: myVegas hack cheats tool | February 07, 2013 at 03:15 PM

Post a comment

Comments are moderated and will not appear until the moderator has approved them.

If you have a TypeKey or TypePad account, please Sign in

December 21, 2012

Try, Try Again

As a regular, satisfied customer of The Wall Street Journal's "Heard on the Street" feature, I was a bit distressed to read this, from an item titled "Bonds Beware Central Bank Regime Change":

In the U.S., the Federal Reserve has announced that future monetary policy tightening will depend on a hard target for falling unemployment and a softer target for rising inflation expectations. That looks like a tilt toward growth as the priority over inflation.

When The Financial Times and The Wall Street Journal in quick sequence publish articles that seem to misinterpret Fed communications, I have to surmise that the message isn't getting through and bears repeating and further explaning.

Earlier this week, in response to the alluded-to FT article, I addressed the charge of a "tilt toward growth as the priority over inflation," noting that Fed Chairman Ben Bernanke clearly indicated in last week's press conference that there has been no "change in our relative balance, weights towards inflation and unemployment...."

It is true that the Committee's threshold for considering policy action was expressed in terms of a realized value for unemployment and a forecast value for inflation. But that choice, as the Chairman explained in that press conference, was motivated by the nature of the two different statistics:

... the Committee chose to express the inflation threshold in terms of projected inflation between one and two years ahead, rather than in terms of current inflation. The Committee took this approach to make clear that it intends to look through purely transitory fluctuations in inflation, such as those induced by short-term variations in the prices of internationally traded commodities, and to focus instead on the underlying inflation trend.

More importantly, the plan is not to ignore the incoming data and rely solely on internal Committee forecasts:

In making its collective judgment about the underlying inflation trend, the Committee will consider a variety of indicators, including measures such as median, trimmed mean, and core inflation; the views of outside forecasters; and the predictions of econometric and statistical models of inflation. Also, the Committee will pay close attention to measures of inflation expectations to ensure that those expectations remain well anchored.

Even more important, in my view, this broad approach to assessing price-stability conditions is also the approach the Chairman described in thinking about the allegedly hard target for the unemployment rate:

... the Committee recognizes that no single indicator provides a complete assessment of the state of the labor market and therefore will consider changes in the unemployment rate within the broader context of labor market conditions.

It is fair to point out the difficulties that can arise in implementing this policy strategy in the real time, real messy world. And if you doubt that the Committee is as good as its word, there is probably not much I can say that will convince you otherwise. But we ought to at least take care in being clear what the Committee's word actually is.

Dave AltigBy Dave Altig, executive vice president and research director at the Atlanta Fed

 


December 21, 2012 in Federal Reserve and Monetary Policy, Monetary Policy | Permalink

TrackBack

TrackBack URL for this entry:
http://www.typepad.com/services/trackback/6a00d8341c834f53ef017c34da9b89970b

Listed below are links to blogs that reference Try, Try Again:

Comments

David: Think about that headline "Bonds Beware Central Bank Regime Change".

That is precisely the message we want the bond market to hear. We want the people holding bonds and money to sell their bonds and money and buy real goods instead, to increase Aggregate Demand. So if the Fed is not saying that, then the Fed ought to be saying that. And if the bond market has indeed misinterpreted the Fed, we ought to be very glad it has misinterpreted the Fed.

Posted by: Nick Rowe | December 22, 2012 at 07:16 AM

Note their words of "softer inflation target". Despite the fact that the Fed has been saying for some time that the 2% target was symmetric, everyone on Wall Street considered the target to be a 2% inflation *ceiling*. The 2.5% threshold of the new rule is an explicit ceiling.

If the Fed was telling the truth before about the previous target being symmetric, then you are correct that the Fed isn't changing its priorities. But if 2% really was a ceiling, then it really is a change.

Posted by: Redwood Rhiadra | December 22, 2012 at 01:56 PM

Post a comment

Comments are moderated and will not appear until the moderator has approved them.

If you have a TypeKey or TypePad account, please Sign in

December 17, 2012

Plain English

Gavyn Davies writes in The Financial Times (hat tip, Mark Thoma) that he sees a major shift in attitude at the Fed:

In the US, there has been a clear shift in the Fed's policy reaction function, or "Taylor Rule", increasing the weight placed on unemployment and reducing the weight on inflation. The nature and importance of the Fed's policy shift has not yet been fully understood, because it was not really spelled out by Chairman Bernanke in his press conference this week.

I'd score that comment about half accurate. Here's what the Chairman actually said in that press conference:

QUESTION:
Mr. Chairman, what prompted the Committee to make the decision at this particular time to specify targets? And by taking an unemployment rate that is quite low compared to currently, does that shift the balance of priorities in terms of your dual mandate…more in the direction of reducing unemployment rather than inflationary pressures?

BERNANKE:
…It is not a change in our relative balance, weights towards inflation and unemployment, by no means. First of all, with respect to inflation, we remain completely committed to our 2 percent longer- run objective. Moreover, we expect our forecast, as you can see from the summary of economic projections, our forecasts are that inflation will actually remain—despite this threshold of 2.5 [percent]—that inflation will actually remain at or below 2 percent going forward…

I think both sides of the mandate are well-served here. There's no real change in policy. What it is instead is an attempt to clarify the relationship between policy and economic conditions.

That's about as clear a statement about the constancy of the Federal Open Market Committee's (FOMC) objectives as I can imagine. The reason I am giving Davies half credit is his reference to the Taylor rule, and his article's theme that what has changed is the FOMC's "reaction function"—a fancy name for how the Fed will respond to changes in economic conditions in pursuit of its objectives.

I think the intent of recent changes in language is pretty clear, evidenced by comparing this statement following the August FOMC meeting

To support a stronger economic recovery and to help ensure that inflation, over time, is at the rate most consistent with its dual mandate, the Committee expects to maintain a highly accommodative stance for monetary policy. In particular, the Committee decided today to keep the target range for the federal funds rate at 0 to 1/4 percent and currently anticipates that economic conditions--including low rates of resource utilization and a subdued outlook for inflation over the medium run--are likely to warrant exceptionally low levels for the federal funds rate at least through late 2014.

… with this one, introduced after the September FOMC meeting:

To support continued progress toward maximum employment and price stability, the Committee expects that a highly accommodative stance of monetary policy will remain appropriate for a considerable time after the economic recovery strengthens. In particular, the Committee also decided today to keep the target range for the federal funds rate at 0 to 1/4 percent and currently anticipates that exceptionally low levels for the federal funds rate are likely to be warranted at least through mid-2015.

I added the emphasis above, as in my view it is the key change from previous statements. At least from the point of view of the Atlanta Fed's research staff, there wasn't much of a shift in the economic forecast between August and September (or September and December, for that matter). The change in date from late 2014 to mid-2015 is (I argue) best understood, not in terms of changing economic conditions, but in terms of this explanation, from Mike Woodford's paper presented at the Federal Reserve Bank of Kansas City's 2012 Economic Symposium:

We argue for the desirability of a commitment to conduct policy in a different way than a discretionary central banker would wish to, ex post, and show that (in our New Keynesian model) the optimal commitment involves keeping the policy rate at zero for some time after the point at which a forward-looking inflation-targeting bank (or a bank following a forward-looking "Taylor Rule") would begin to raise interest rates.

This, of course, is exactly the change in reaction function to which Davies refers. But two points need to be emphasized. First, the deviation from the Taylor rule that Woodford describes is an exceptional measure designed to deal with circumstances in which policy rates have fallen to zero and can fall no more. Deploying such measures in the current extraordinary circumstances need not reflect some fundamental change in the approach to policy when things return to conditions that more closely approximate normal.

Second, and more importantly, the Chairman's comments make it abundantly clear that whatever changes may have occurred in how monetary policy is implemented, there is in no way a change in the weight the Committee puts on its price stability mandate. On that there should be no confusion.

Dave AltigBy Dave Altig, executive vice president and research director at the Atlanta Fed

 

December 17, 2012 in Federal Reserve and Monetary Policy, Monetary Policy | Permalink

TrackBack

TrackBack URL for this entry:
http://www.typepad.com/services/trackback/6a00d8341c834f53ef017d3ee5544d970c

Listed below are links to blogs that reference Plain English:

Comments

Post a comment

Comments are moderated and will not appear until the moderator has approved them.

If you have a TypeKey or TypePad account, please Sign in

November 02, 2012

Has Fed Behavior Changed?

To the titular question, Steve Williamson thinks the answer is "yes":

… the behavior of the FOMC has changed. Either it cares about some things it did not care about before (and in a particular way), or it cares about the same things in different ways—in particular it is less concerned about its price stability mandate.

Part of the Williamson case relies on an earlier post, where Williamson illustrates deviations of the actual path of the federal funds rate paths from his own estimated version of the Taylor rule:

New Keynesians like to think about monetary policy in terms of a Taylor rule, which specifies a target for the federal funds rate as a function of the "output gap" and the deviation of the actual inflation rate from its target value. According to standard Taylor rules, the fed funds target should go down when the output gap rises and up when the inflation rate rises. You can even fit Taylor rules to the data. I fit one to quarterly data for 1987-2007, and obtained the following:

R = 2.02 - 1.48(U-U*) + 1.17P,

where R is the fed funds rate, U is the unemployment rate, U* is the CBO natural rate of unemployment (so U-U* is my measure of the output gap) and P is the year-over-year percentage increase in the PCE deflator. You can see how it fits the historical data in the next chart.

So that's how the Fed behaved in the past. If it were behaving in the same way today, what would it be doing? Given that U = 7.8, U* = 6.0, and P = 1.5, my Taylor rule predicts R = 1.1%....

So, the Fed's behavior seems to have changed.

An obvious point: It is clear from Williamson's chart above that the predictive power of his version of the Taylor rule is far from perfect. In fact, through 2007 the standard deviation of the estimated rule's prediction error is 1.3 percentage points. From that perspective, the difference between a Williamson-Taylor rule funds-rate prediction of 1.1 percent and the actual current value of 0.14 percent doesn't seem so dramatic. I don't really see an obvious deviation from previous behavior.

More to the point, unless the metric is an absolutely slavish devotion to a particular form of the Taylor rule, I'm not exactly sure what evidence supports a conclusion that the Federal Open Market Committee (FOMC) is now "less concerned about its price stability mandate." As I argued a few weeks back, I think it is not too much of a stretch to construct a justification of post-crisis Fed actions up to the September decision entirely in terms of support for the FOMC's price stability mandate.

I don't take any great exception to Williamson's claim that, with respect to the FOMC's stated inflation objective, things look pretty much on target:

If we look at a longer horizon, as I did here, from the beginning of 2007 or the beginning of 2009, you'll get something a little higher than 2.0% (I didn't have the most recent observation in the chart in the previous post). Too low? I don't think so.

Furthermore, in my previous post I noted that while there is a plausible case that previous asset purchase programs were required to maintain this salutary record on the inflation front, the case is arguably less plausible for "QE3." But, to my mind, that just isn't enough evidence to conclude that the FOMC has downgraded its price stability goals.

Consider a homeowner with the dual mandate of keeping both the roof of the house and the driveway in good repair. If the roof isn't leaking but there are cracks in the driveway, I think you would expect to see the owner out on the weekend patching the concrete. I don't think you would conclude as a result that he or she had ceased caring as much about the condition of the roof. I do think you would conclude that attention is being focused where the problem exists.

I suppose the argument is that the Fed is raining so much liquidity down on the world that the roof is, sooner or later, bound to leak. The FOMC has expressed confidence that, if this happens, it has the tools to patch things up and will deploy those tools as aggressively as required to meet its mandate. I guess Steve Williamson feels differently. But that, then, is a difference of opinion about things to come, not about the facts on the ground.

Update: Here's Steve Williamson's response.

David Altig By Dave Altig, executive vice president and research director at the Atlanta Fed

November 2, 2012 in Federal Reserve and Monetary Policy, Inflation, Monetary Policy | Permalink

TrackBack

TrackBack URL for this entry:
http://www.typepad.com/services/trackback/6a00d8341c834f53ef017d3d374d31970c

Listed below are links to blogs that reference Has Fed Behavior Changed?:

Comments

I think Williamson's problem is that his U*=6 is wrong. There's been plenty of discussion in the econosphere about how the CBO's estimates of output and employment potential have been downwardly biased in recent years. Part of this reflects uncertainty about the extent to which the downturn was structural, but a lot of it is also just a matter of the data being truncated--as more data comes in, the trend estimates will be revised back up due to smoothing processes.

The results on Williamson's Taylor rule are dramatic. First, update the current unemployment to 7.9 instead of the previous 7.9 and it drops from R=1.1% to just 0.98%. Then lower the natural rate of unemployment down to a more realistic long run rate of 5.5% and the predicted interest rate drops to 0.22%, which is within the window prescribed by the fed.

Now, 5.5% is much closer to the natural rate normally used in Taylor rule calculations. Williamson did not find evidence that the Fed was behaving differently, but rather advocating that it should behave differently by being more pessimistic than normal about the economy's potential.

Posted by: Matthew | November 04, 2012 at 07:32 AM

Post a comment

Comments are moderated and will not appear until the moderator has approved them.

If you have a TypeKey or TypePad account, please Sign in

October 09, 2012

Supporting Price Stability

All of the five questions that Chairman Ben Bernanke addressed in his October 1 speech to the Economic Club of Indiana rank high on the list of most frequently asked questions I encounter in my own travels about the Southeast. But if I had to choose a number one question, on the scale of intensity if not frequency, it would probably be this one: "What is the risk that the Fed's accommodative monetary policy will lead to inflation?"

The Chairman gave a fine answer, of course, and I hope it is especially noted that Mr. Bernanke was not dismissive that risks do exist:

"I'm confident that we have the necessary tools to withdraw policy accommodation when needed, and that we can do so in a way that allows us to shrink our balance sheet in a deliberate and orderly way. ...

"Of course, having effective tools is one thing; using them in a timely way, neither too early nor too late, is another. Determining precisely the right time to 'take away the punch bowl' is always a challenge for central bankers, but that is true whether they are using traditional or nontraditional policy tools. I can assure you that my colleagues and I will carefully consider how best to foster both of our mandated objectives, maximum employment and price stability, when the time comes to make these decisions."

While the world waits for "take away the punch bowl" time to arrive, here is another question that I think worthy of consideration: "Looking back over the past several years, what is the risk that the Fed's price stability mandate would have been compromised absent accommodative monetary policy?"

As the Chairman noted in his speech, it isn't easy to take the evidence at hand and argue any inconsistency between the Federal Open Market Committee's (FOMC) policy actions and its price stability mandate:

"I will start by pointing out that the Federal Reserve's price stability record is excellent, and we are fully committed to maintaining it. Inflation has averaged close to 2 percent per year for several decades, and that's about where it is today. In particular, the low interest rate policies the Fed has been following for about five years now have not led to increased inflation. Moreover, according to a variety of measures, the public's expectations of inflation over the long run remain quite stable within the range that they have been for many years."

To the question I posed earlier, I am tempted to take those observations one step further. Without the policy steps taken by the FOMC over the past several years, the "excellent" price stability record would indeed have been compromised.

Consider the so-called five-year/five-year-forward breakeven inflation rate, a closely monitored market-based measure of longer-term inflation expectations. If you are not completely familiar with this statistic—and you can skip this paragraph if you are—think about buying a Treasury security five years from now that will mature five years after you buy it. When you make such a purchase, you are going to care about the rate of inflation that prevails between a period that spans from five years from today (when you buy the security) through 10 years from today (when the asset matures and pays off). By comparing the difference between the yield on a Treasury security that provides some insurance against inflation and one that does not, we can estimate what the people buying these securities believe about future inflation. The reason is that, if the two securities are otherwise similar, you would only buy the security that does not provide inflation insurance if the interest rate you get is high enough relative to inflation-protected security to compensate you for the inflation that you expect over the five years that you hold the asset. In other words, the difference in the interest rates across an inflation-protected Treasury and a plain-vanilla Treasury that does not provide protection should mainly reflect the market's expected rate of inflation.

When you look at a chart of these market-based inflation expectations along with the general timing of the FOMC's policy actions, from the first large-scale asset purchase in 2008–2009 (QE1) to the second asset purchase program (QE2) in 2010 to the maturity extension program (Operation Twist) in 2011, the relationship between monetary policy and inflation expectations is pretty clear:

In each case, policy actions were generally taken in periods when the momentum of inflation expectations was discernibly downward. A simple-minded conclusion is that FOMC actions have been consistent with holding the bottom on inflation expectations. A bolder conclusion would be that as inflation expectations go, so eventually goes inflation and, had these monetary policy actions not been taken, the Fed's price stability objectives would have been jeopardized.

Statements like this do not come without caveats. A perfectly clean measure of inflation expectations requires that Treasuries that do and do not carry inflation protection really are otherwise identical. If that is not the case, differences in rates on the two types of assets can be driven by changes in things like market liquidity, and not changes in inflation expectations. Calculations of five-year/five-year-forward breakeven rates attempt to control for some of these non-inflation differences, but certainly only do so imperfectly.

Perhaps more pertinent to the current policy discussion, inflation expectations have, in fact, moved up following the latest policy action—which I guess people are destined to call QE3. But unlike the periods around QE1, QE2, and Twist, QE3 was not preceded by a period of generally falling longer-term breakeven inflation rates. So this time around there will be another, and perhaps more challenging, chance to test the proposition that monetary accommodation is consistent with price stability. As for previous actions, however, I'm pretty comfortable arguing the case that the price stability mandate was not only consistent with accommodation, it actually required it.

Dave AltigBy Dave Altig, executive vice president and research director at the Atlanta Fed

 


October 9, 2012 in Monetary Policy | Permalink

TrackBack

TrackBack URL for this entry:
http://www.typepad.com/services/trackback/6a00d8341c834f53ef017d3c816303970c

Listed below are links to blogs that reference Supporting Price Stability:

Comments

Perhaps the market simply expects financial repression to continue indefinitely, as is happening now amid negative real interest rats on Fed purchases, and has happened previously for decades and longer.

It's best to look at measures not distorted now, or able to be distorted in the future, since the market is well aware of these possibilities.

For example, what do gold prices and their movement in front of, an in response to QE announcements, signal about inflation expectations - certainly not deflation.


Posted by: HistorySquared | October 16, 2012 at 04:47 PM

As per Federal bank technical research report one should go short in this counter. Federal bank is looking quite weak at current level and is expected to fall further. Positional traders can go short in Federal bank from current level for good gains.

Posted by: Intraday Tips | October 18, 2012 at 03:02 AM

Post a comment

Comments are moderated and will not appear until the moderator has approved them.

If you have a TypeKey or TypePad account, please Sign in

August 24, 2012

The Cost-Benefit Challenge

In its latest Room for Debate feature, The New York Times poses the question "Should the Fed Risk Inflation to Spur Growth?" Befitting a balanced panel of blogging experts, Mark Thoma (Economist's View) says "yes," John Cochrane (The Grumpy Economist) says "no," and Edward Harrison (Credit Writedowns) says something like "irrelevant question, it's going to do neither."

The whole discussion, naturally, is about differing assessments of the costs and benefits of additional monetary stimulus. Not surprisingly, this was also a theme disclosed in the just released minutes of the July 31–August 1 meeting of the Federal Open Market Committee:

Participants also exchanged views on the likely benefits and costs of a new large-scale asset purchase program. Many participants expected that such a program could provide additional support for the economic recovery both by putting downward pressure on longer-term interest rates and by contributing to easier financial conditions more broadly. In addition, some participants noted that a new program might boost business merits of purchases of Treasury securities relative to agency MBS. However, others questioned the possible efficacy of such a program under present circumstances, and a couple suggested that the effects on economic activity might be transitory. In reviewing the costs that such a program might entail, some participants expressed concerns about the effects of additional asset purchases on trading conditions in markets related to Treasury securities and agency MBS, but others agreed with the staff's analysis showing substantial capacity for additional purchases without disrupting market functioning. Several worried that additional purchases might alter the process of normalizing the Federal Reserve's balance sheet when the time came to begin removing accommodation. A few participants were concerned that an extended period of accommodation or an additional large-scale asset purchase program could increase the risks to financial stability or lead to a rise in longer-term inflation expectations...

The questions about the costs and benefits of any particular policy intervention are abundant, and for virtually every potential pro there is a potential con. Here is my personal, certainly incomplete list of pros/cons or benefits/costs associated with another round of large-scale asset purchases:

Pro:  Lower interest rates (and perhaps a lower dollar) will on balance spur spending.
Con:  The expectation of low interest rates for a longer period of time will reduce the urgency to borrow and spend.
Pro:  Expanded asset purchases and lower rates will preserve needed liquidity in financial markets.
Con:  Expanded asset purchases and lower rates will create or exacerbate financial market distortions.
Pro:  More monetary stimulus reduces the probability of an undesirable disinflation in the near term.
Con:  More monetary stimulus increases the probability of undesirable inflationary pressures in the longer term.
Pro:  Lower Treasury and MBS rates will induce an appetite for risk taking that is needed to get productive resources "off the sidelines."
Con:  Lower Treasury and MBS rates will induce an appetite for risk taking that sets us up for the next bubble.
Pro:  Monetary policy is the only channel of support for the economy, absent new fiscal policies.
Con:  Monetary policy support is relieving the pressure to make needed fiscal reforms that would be much more effective than monetary stimulus.
Pro:  With additional monetary stimulus, GDP growth will be higher and unemployment lower than they would otherwise be, and outcomes may be more consistent with the FOMC's mandate to promote maximum employment.
Con:  With additional monetary stimulus, the exit from monetary stimulus once the economy improves will be more difficult than it would otherwise be, and outcomes may be inconsistent with the FOMC's mandate to achieve price stability.
Pro:  The performance of the economy has not been consistent with the FOMC's mandated objectives.
Con:  The economy is slowly moving in the direction of the FOMC's mandated objectives, and the Fed should "keep its powder dry" in case of further deterioration of the economy.


Many, if not all, of these benefits and costs are familiar, and there has been no shortage of opinions advanced. To some extent, it is inevitable that the weighting of these costs and benefits will be to a large degree judgmental. How one weights the risks associated with continued high rates of unemployment versus the risks of imbalances that may arise from low interest rates, for example, is a subjective thing.

Nonetheless, it would be helpful to frame these subjective judgments with a background of some hard evidence. For example, how much employment can we gain for a given quantity of asset purchases (or any other monetary policy option on the table)? What are the likely—or existing—distortions created by low interest rates, and what do we think are the tangible costs associated with those distortions? And so on.

So, here is my challenge question: No matter what your opinion about what should be done, and whether you arrive at a conclusion by casual observation, econometric studies, or historical evidence, what do you think is the best evidence concerning any or all of these costs and benefits?

OK, then. Bloggers blog, commentators comment.

Update: Jon Hilsenrath sizes up some of the costs of a new bond-buying program.

David AltigBy Dave Altig, executive vice president and research director at the Atlanta Fed

 


August 24, 2012 in Federal Reserve and Monetary Policy, Monetary Policy | Permalink

TrackBack

TrackBack URL for this entry:
http://www.typepad.com/services/trackback/6a00d8341c834f53ef0176176b63fc970c

Listed below are links to blogs that reference The Cost-Benefit Challenge:

Comments

I think the Fed has destroyed its credibility on the full employment front and hence the aggregate demand front. Expectations are coming completely unmoored.

For example, the looming 'fiscal cliff' would be considered a non-event if the Fed could be counted on to maintain nominal demand. However, years of opportunistic disinflation confuse any signal and make recession much more likely next year, thanks to political dysfunction and Fed fecklessness.

Without credibility on the AD front you are all making your own jobs much harder than it should be.

Posted by: OGT | August 25, 2012 at 09:45 AM

Good, hard question. But we might not have to answer it if fiscal policymakers would do a much easier cost-benefit analysis. The U.S. govrnment can borrow money in the TIPS market for 30 years at a real rate of 0.42%. Surely, SURELY, there are some long-lived infrastructure investment projects that aren't underway right now that will generate an internal rate of return higher than tat over their useful lives.

Posted by: ASG | August 27, 2012 at 12:20 PM

unfortunately you did not number the arguments.

con #1,3,4,6,7 are arguments that apply to any period of Fed easing. If you accept these then the FOMC should disband, do nothing, and never try to ease, because cutting rates deeper means makes it takes more time to raise them back to neutral. They are also in direct contradiction to Bernanke's testimony that the Fed has suitable room to unwind the balance sheet. Implicit in most is the booms-cause-busts theory of the business cycle.

If the Fed is steering the bus, then it can control the speed.

Con #2 has been rebutted by the Fed's internal research, and we have not seen any evidence for it.

Con #5 accepts the flawed theory that the FOMC should be defacto Senators or elected representatives that put pressure on Congress. It accepts the flawed, disproven, German idea of expansionary fiscal contraction.

Fundamentally, most of these arguments against action are tantamount to the business cycle solves itself and the Fed cannot control the economy. If that's the case, then we should disband the FOMC and save the taxpayers money. Really, FOMC members should thus be justifying their jobs.

Posted by: dwb | August 27, 2012 at 02:10 PM

can i posit a different cost/benefit analysis? with the fiscal mechanism broken? I fail to see who is benefiting from zero rates?!?! so at this point i can name a whole host of cons and less and less pros for the zero bound. For the sake of keeping it short I'll take the first shot across the bow on the zero rate regime, INTEREST INCOME 2007 was $492bln now its $64bln a DROP of $428bln.. WOW, meanwhile (roughly) DEBT Servicing has dropped $195bln.. MAYBE INCOMES WILL GO UP WITH RATES?? thats just the beginning of a very long argument. The purpose of low rates was clear before, but becomes increasingly unclear to me over time.

Posted by: cidiel | August 29, 2012 at 09:43 AM

Thanks - love the pros/cons list. Keep them coming!

Posted by: RebBowDur | September 04, 2012 at 07:05 PM

When we analysis cost and benefit analysis on any business so, it changes business to business. As, it depend o the business which we are handling. Before making any policies, we should first analysis it's pros and cons, as its meter a lot in any business.

Posted by: joshef | December 14, 2012 at 01:31 AM

Post a comment

Comments are moderated and will not appear until the moderator has approved them.

If you have a TypeKey or TypePad account, please Sign in