In 2009, Air France Flight 447 crashed while on route from Rio to Paris. Data from the flight recorder suggest multiple problems led to the disaster. In a stressful and confusing environment, one of the copilots moved a control stick in the wrong direction, which worsened the problem of the plane stalling.
After a major plane crash, investigators look at the “black box” to determine instruments settings—did the captain make the right decisions? Thus, suppose the captain insisted that he or she had been unable to lower the flaps, while the flight recorder showed multiple examples of the flaps being raised and lowered throughout the flight. In that case, one might doubt the captain’s explanation.
Similarly, it may be useful to examine central bank “black boxes”. Do the movements in their policy instruments match the macroeconomic problems they faced and the goals they wished to achieve? Do they match any explanation they provide for a failure to achieve those goals?
During the late 2010s, the Fed was fairly consistently undershooting its inflation target. This led some observers to speculate that the Fed was unable to raise inflation. This is from a 2017 FT article:
Blanchard was prompted to recite his faith in the power of the Phillips Curve by former Fed governor Jeremy Stein, who wondered how central banks were supposed to raise their inflation target to 4 per cent when they are still undershooting the current target of 2 per cent.
Stein is implicitly suggesting an inability to raise inflation rates. But if we look at the Fed’s “black box”, we see nine rate increases between 2015 and 2018. This rules out “instrument failure”, and instead leads to three possibilities:
1. Like the Flight 447 co-pilot, and like the Prime Minister of Turkey, the Fed was horribly confused. They wrongly believed that raising the policy rate would boost inflation up to their target. They pushed the instrument in the wrong direction.
2. Fed officials are corrupt, privately aiming for below 2% inflation even as they publicly insisted that they were targeting inflation at 2%.
3. Fed officials were mistaken in relying on flawed Phillips Curve models that suggested that inflation would soon overshoot the 2% target without further rate increases.
In my view, the third explanation is the mostly likely, but at least we can rule out instrument failure as an option. The Fed was perfectly able to adjust its fed funds target.
Britney Spears informs us that one romantic affair might be an innocent mistake, but multiple affairs are the sign that you are dealing with a bad girl. Perhaps this insight can be used when evaluating the black boxes of the Bank of Japan and the ECB.
In the early 2000s, the Bank of Japan apologists insisted that there was nothing the BOJ could do to boost inflation despite its valiant efforts. But in the year 2000, our black box shows the BOJ raising its interest rate target, despite years of deflation. Why did it do this?
The small increase in interest rates might have been an innocent mistake. But the BOJ again increased its interest rate target in 2006, clearly demonstrating that (as Britney would say) the BOJ is “not that innocent”.
ECB apologists insist that the European central bank was unable to prevent the Great Recession. But the ECB’s black box shows the ECB raising interest rates in mid-2008, right before the economy worsened dramatically. The black box also shows two rate increases in early 2011, right before Europe fell into a double dip recession.
Of course we know that the level of interest rates is not a reliable indicator of the stance of monetary policy, just as the position of a control lever doesn’t tell you how the position of the airliner is changing. But when we juxtapose the central bank instrument setting against the clear needs of the economy, we do have evidence of intent. One mistake might be an innocent error, multiple BOJ and ECB mistakes were evidence of an overly hawkish central bank.
In 1986, CBS News informed us that Audi cars had a problem with “unexplained sudden acceleration”. One hint that this was actually human error was the fact that hitting the brake seemed to make the problem worse. In a car, the brake and drivetrain are completely separate systems, making it very unlikely that a mechanical failure could cause the car to accelerate after hitting the brake. Investigators later speculated that Audi had placed the brake and accelerator pedals a bit closer than usual, and that some drivers had hit the accelerator while intending to hit the brake.
I think of this example when considering Fed apologists who claim that there’s nothing the Fed can do about high inflation, as it’s caused by supply chain problems. If we look at the Fed black box for 2021, we see a central bank holding their policy rate near zero for the entire year, and continuing (even in 2022!) to inject more and more money into the economy via QE.
Central banks often plead innocent when accused of making major policy errors. Fortunately, we have independent evidence from central banks black boxes, which clearly demonstrate that they are “not that innocent”.
READER COMMENTS
marcus nunes
Jan 17 2022 at 5:05pm
Exactly! And additional evidence comes from the fact that they try to “hide” the errors. In 1937:
“Particularly enlightening is the reasoning offered by Williams as to why a reversal of the earlier tightening action would be ill advised. We all know how it developed. There was a feeling last spring that things were going pretty fast … we had about six months of incipient boom conditions with rapid rise of prices, price and wage spirals and forward buying and you will recall that last spring there were dangers of a run-away situation which would bring the recovery prematurely to a close. We all felt, as a result of that, that some recession was desirable … We have had continued ease of money all through the depression. We have never had a recovery like that. It follows from that that we can’t count upon a policy of monetary ease as a major corrective. …[Doesn´t that sound familiar?]
In response to an inquiry by Mr. Davis as to how the increase in reserve requirements has been in the picture, Mr. Williams stated that it was not the cause but rather the occasion for the change. … It is a coincidence in time. …”
And Tim Geithner in 2008:
Scott Sumner
Jan 18 2022 at 9:44am
Very good comment. Geithner’s remark is chilling.
Rajat
Jan 17 2022 at 5:27pm
I think a key bit you didn’t mention is expectations of future inflation – as you have previously noted, they are presently above-target and remain so in spite of the market expecting something like four Fed fund rate hikes this year. Whereas in 2008, inflation had been high but was not expected to remain high. If inflation were today expected to return rapidly to target or below-target because of an implicit view that supply chain issues would resolve quickly and restore pre-pandemic levels of potential output, then – like 2008 – it might be appropriate for the Fed to ‘look through’ the recent and impending higher inflation.
Thomas Lee Hutcheson
Jan 18 2022 at 6:59am
Expectations ARE above 2% PCE, but not by much. I see this as markets thinking the Fed has almost “got it.” I’d also prefer it the Fed rather than signaling a certain number of increase in ST rates would just double down on getting expectations back a lot closer to 2% as they were in the summer of 2021.
The Fed last September should not have just “expected” the increase in inflation to be temporary but said that it would “do what it takes” to make sure it WAS temporary. That was the time to start dialing back LT bond purchases.
It should also ask Treasury to issue some 2 and 3 year TIPS to provide a better take on expectations.
Scott Sumner
Jan 18 2022 at 9:46am
I agree about what the Fed should have done in September, but I’d go even further. Getting inflation back down to 2% should not be the goal. Inflation needs to fall below 2%.
David S
Jan 19 2022 at 2:49am
I’m beginning to wonder if FAIT is effectively dead. Supply chain issues have held up the “Team Transitory” t-shirt I ordered in October. When it arrives, I might be too embarrassed to wear it in public, or when commenting on economics blogs.
However, I will have no shame wearing the shirt that says “Welcome back to the 90’s kids!” because I think that inflation and growth trends will match the later stages of the Volcker regime. Granted, it took a few years to drive PCE down to the 2% range, but I would be okay with that in our current circumstances–although I think Fed actions over the next few months will be much faster. I may get to wear the first t-shirt someday.
Alan Goldhammer
Jan 18 2022 at 8:07am
The Audi car story keeps rising up from the ashes and the solution was not speculation as Scott writes. Brock Yates, the automotive writer, had a regular column in the WaPo at the time of the 60 Minutes story and called BS on it quickly. He instructed readers to perform the following experiment (which can be done in any car). Put your left foot on the brake pedal as hard as you can and then hit the gas and see what happens. Spoiler alert: the Audi 5000 that Yates used for the test stalled as expected. All the bad things that happened were a result of driver error and Audi spent huge amounts of money trying to remediate this problem.
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