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The Atlanta Fed's macroblog provides commentary and analysis on economic topics including monetary policy, macroeconomic developments, inflation, labor economics, and financial issues.

Authors for macroblog are Dave Altig, John Robertson, and other Atlanta Fed economists and researchers.


« Roach To Fed: J'Accuse! (II) | Main | Roach To Fed: J'Accuse! (The End) »

April 27, 2005


Roach To Fed: J'Accuse! (III)

The Roach saga continues:

This whole story, in my view, remains balanced on the head of a pin of absurdly low real interest rates.   And the Fed has certainly been pivotal in nurturing this low-interest-rate regime.  In an extraordinary display of policy accommodation, the real federal funds rate is only now moving above the zero threshold after having spent three years in negative territory.  Of course, a central bank has little choice to do otherwise if it has made a conscious decision to underwrite the Asset Economy.

In my view, Mr. Roach is making a classic mistake: Confusing a low federal funds rate with "an extraordinary display of policy accommodation."  If I may, I will quote from myself:

A “neutral” monetary policy—one that avoids both inflationary and disinflationary pressures (as well as both artificial stimulus and unwarranted restraint on the pace of real economic activity)—requires that the funds rate target adjust to the evolving demand in credit markets as consumption, investment, and employment expand in anticipation of continued growth...

How far, and how fast, must the funds rate rise? What is neutral? It should be clear from this discussion that the answer is wholly dependent on economic developments well outside the scope of monetary policy. “Neutral” can only be defined relative to the state of the economy at a particular point in time. The economy of mid-2000 through mid-2003, characterized by distinct weakness in investment spending and employment growth, inevitably meant low real interest rates. Neutral in that situation meant a low—perhaps very low—funds rate to contain disinflationary pressures building in the economy.

Now, as the economy strengthens and investment and employment growth recover, the neutral setting of the funds rate is moving up. The distance it will go depends on myriad factors, most (if not all) of which will only be revealed in time (perhaps at a measured pace). 

The suggestion that the low interest rates we have lived with over the past several years is proof of exceptionally stimulative policy is flat-out wrong.  A corollary, of course, is that it is not generally possible to put a number on what "restrictive" is at any point in time.  Hence, Roach predicts...

Given the excesses that now exist, it may even require a federal funds rate that needs to move into the restrictive zone -- possibly as high as 5.5%.

... and I, for one, would accept the proposition that 5.5% would be restrictive in the current environment.  But I might also accept the proposition that something quite a bit lower than 5.5% would be restrictive.  Or that if and when we get there, 5.5% will not be restrictive at all.  After all, the funds rate was at 5.5% in the summer of 1997 when, according to Roach view of the world, policy was fueling the stock market bubble.

One more to go.

April 27, 2005 in Federal Reserve and Monetary Policy | Permalink

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Comments

David: You and I disagree about some things, but on monetary policy we seem to have broader agreement. I have trouble with some of what Greenspan has failed to do as watchdog of the public interest, but the Fed presidents and governors have been much tougher and have sounded alarms. Just yesterday I posted this from the president of the Cleveland Fed, which I thought was a remarkably strong statement to be made in public by a Fed official:

[Pianalto] also notes that the public can help the Federal Reserve with its job. She says “... it goes without saying that our job is made easier if the public expects that the fiscal authorities will address budgetary imbalances in a timely and effective fashion.”…

A large part of the point of my post was to note her call for public pressure to reign in the deficit. That cannot be construed as an enabling statement.

There are those who will say too little too late, and I haven't been completely happy with some of the lack of concern over the current account and federal deficits, but there is room for honest disagreement there.

By and large, the Fed has probably gotten it mostly right. I don't like having interest rates so low that you have no room to go lower if a really bad shock hits, it's a bit like going without insurance, but by and large I can't be overly critical of how they have operated. You are absolutely correct that the target MUST move, and right now I would argue that is moving upward (and perhaps more quickly than many realize because the AS shocks are being masked to some degree by positive AD shocks due to the deficit, but I wouldn’t push that too hard). I always hesitate to write that – I get called an inflation hawk, but I’m not, I’m an output stability hawk and that’s what it takes to get there. I just have to take more time to educate people about how the target moves over time and why it must be followed to avoid inflationary/deflationary policies and why that stabilizes output in the process, the real goal.

I challenge those who believe the Fe has made large mistakes to point to explicit negative consequences of Fed behavior. I've written about the failure to sound an alarm over the behavior of congress over the deficit/trust fund, and I believe rightfully so as watching out for the public interest is an important role of the Fed, but that's not something the Fed had direct control over and other than publicly denouncing such policy, they have little choice but to do their best in spite of poor policy elsewhere in government.

I don't want to tear down the entire Fed, it is a well-functioning institution. My displeasure is with Greenspan since January 2001 and other narrower issues. I don’t want anyone to confuse my displeasure with aspects of the Fed with a general indictment of its behavior. It has served us well, and will continue to do so as long as it maintains strict independence from other parts of government (but remember, the chair is an intentionally political position – that’s where the administration is allowed to have its say in Fed policy).

Posted by: Mark Thoma | April 27, 2005 at 11:55 PM

Mark Thoma--"I challenge those who believe the Fe has made large mistakes to point to explicit negative consequences of Fed behavior."

That's an easy one.

Encouraging home equity extraction, and shifting to variable interest mortgages.

See my remarks under Dave's fourth (end) post.

Posted by: Movie Guy | April 28, 2005 at 02:45 AM

Well, it certainly seems no one among Greenspan's defenders is willing to touch the topic of the 'maestro's' push of adjustable mortgages. What gives?

Also, I think Roach's diatribe takes place within a political context, in which Roach has influence domestically that he doesn't have with the Asian Central Banks. The latter bear some responsibility for our housing bubble, as their financing of our deficits keeps long term interest rates lower than they would otherwise be. His anger, in other words, is a symptom of how our country has ceded control of our economic destiny.

Posted by: camille roy | April 28, 2005 at 03:29 PM

Well, it certainly seems no one among Greenspan's defenders is willing to toudh the topic of the 'maestro's' push of adjustable mortgages. What gives?

Also, I think Roach's diatribe takes place within a political context, in which Roach has influence domestically that he doesn't have with the Asian Central Banks. The latter bear some responsibility for our housing bubble, as their financing of our deficits keeps long term interest rates lower than they would otherwise be. His anger, in other words, is a symptom of how our country has ceded control of our economic destiny.

Posted by: camille roy | April 28, 2005 at 03:31 PM

Mark --

You are right -- we broadly agree. And I encourage more discussion of the notion that the neutral policy rate is not a constant (or even a constant range). We can provide enough education on that point.

MG and Camille -- As I suggested in my response to Movie Guy's first comment on the topic, I was not intending to defend every word ever uttered by some Fed official. I still beleive, however, that that the weight of the comments coming from the FOMC participants has been pretty clear about concerns for imbalances in policy and some markets. But I sense that some people think any expression of optimism or calm is a violation of the public trust. That I can't buy.

Posted by: Dave Altig | April 29, 2005 at 08:58 AM

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