Should declining mobility impact monetary policy?
By Scott Sumner
David Beckworth has a new post discussing the implications of declining interstate mobility for whether or not America is an optimal currency area. Adam Ozimek has a post suggesting that lower labor mobility might imply a need for additional monetary stimulus:
So overall, we less mobility out of struggling places, and even if we could incentivize more mobility out of struggling places it is likely that this adjustment measure’s efficacy has fallen as declining populations create a different negative economic shock that would counteract the positive effects of a tighter labor market. What is the implication for monetary policy? If the Fed was setting interest rates for the worst performing 20% of the U.S., it would keep interest rates lower for longer. This would result in overheating in some parts of the country that are farther along in their recoveries. However, the costs of above trend inflation in the cyclically recovered parts of the country are lower than the costs of remaining cyclical slack in the struggling parts. Letting inflation run ahead of target will help the places that are behind catch up, while those places that are ahead will merely experience some low cost excess inflation.
I don’t think this is correct, although I have an open mind on the issue. Here are some thoughts:
1. The Fed targets inflation at 2%. Monetary theory suggests that policy is roughly superneutral with respect to changes in trend inflation, at least in the long run. That means there is no long run trade off between inflation and unemployment. The average unemployment rate will be about the same at 2% trend inflation and 6% trend inflation. I say “roughly” because this is not exactly true, but the science of economics is not far enough advanced to know whether average unemployment would be slightly lower at 6% trend inflation, or slightly higher.
2. Because of point one, it’s meaningless to talk about monetary policy “hawks” and “doves”. A hawk or a dove is someone who does not have a clear understanding of monetary theory. The decline in mobility has no obvious implications for the optimal trend rate of inflation.
3. Ozimek’s post doesn’t mention a higher trend rate of inflation, but rather the possibility that monetary policy should be more expansionary at this point in time. This raises the question of whether declining mobility impacts the optimal degree of flexibility in the Fed’s “flexible inflation target.” This is certainly possible.
4. The best way to think about flexibility is to start by imagining a simple inflation target—single mandate—and then consider what happens if Congress adds a second mandate for employment. Most economists don’t think the second mandate affects the optimal trend rate of inflation (except ruling out ultra-low trend inflation), but do think that it impacts the optimal cyclicality of inflation. With a dual mandate, policy should be a bit more expansionary during periods of high unemployment and a bit more contractionary during periods of low unemployment. That is, policy would be slightly more countercyclical—“leaning against the wind.” NGDP targeting is one example.
5. I’m not sure how declining labor mobility impacts the optimal degree of flexibility, but I’d guess that it implies that the Fed should pay a bit more attention to unemployment than would be the case if labor mobility were high. Adam seems to have the same view.
6. The unemployment rate is currently 4.3%, which is the lowest rate since 1970, excluding a two-year period around the millennium. Obviously this is a period of relatively low unemployment. Thus if we are going to ask monetary policy to pay a bit more attention to the unemployment rate, then we’d actually want a tighter monetary policy at this point in time.
In general, the best way to think about monetary policy is not to imagine what sort of policy would make us better off at this moment in time (that would almost always be a more expansionary policy), but rather what sort of monetary regime performs best over a long span of time, given the structure of the economy. For this timeless perspective, the issue is not about hawks vs. doves, it’s about how much weight to put on the employment part of the dual mandate. But remember, if you put more weight on employment it means a tighter monetary policy when the unemployment rate is lower than average—like right now.
I wish monetary policy could always be more expansionary than average, but unfortunately that only works in one place:
PS. I think you could actually make a stronger argument for declining mobility creating a need for a higher inflation target—based on how the zero bound problem affects the Fed’s ability to hit its dual mandate. But that’s very different from calling for easier money right now.