The Fed knew
David Beckworth has a very interesting podcast with George Selgin. This exchange caught my eye:
Beckworth: Well, I was about to say we now provide a forecasted nominal GDP gap series, which is nice because it actually comes out on a monthly basis. It’s a forecast of a quarterly series, nominal GDP. But every month, the blue-chip forecasters update their forecast on nominal GDP, so it’s a nice metric. In fact, I was talking to Evan Koenig of the Dallas Fed recently. In fact, he was at the Hoover Monetary Policy Conference, and he said they were at the Dallas Fed forecasting, looking at nominal GDP. And they didn’t have this fancy nominal GDP gap model. They’re just doing basic nominal GDP forecasting. And they knew, man, by third, fourth quarter, it was going to be going above trend, and things should have tightened sooner.
Selgin: Evan is one of the sources that I was relying on. I follow what he says on these topics very closely, so I also drew on that.
A year ago, I did not realize that the Fed had decided not to make up for inflation overshoots with lower than average future inflation, which is required under average inflation targeting. Or even to offset overshoots of NGDP, which is appropriate under some plausible interpretations of flexible average inflation targeting. If I had known, I would have been freaking out about inflation even earlier.
But the Fed knew. Given what we now know about their FAIT policy regime and their NGDP forecasts, their behavior seems increasingly incomprehensible. What were they thinking?
Jun 13 2022 at 6:21pm
What was President Biden thinking by reappointing Chairman Powell? As you’ve mentioned, Powell isn’t even really a true expert in economics. It seems likely that inflation wouldn’t have been handled much differently by most experts, but shouldn’t there be some accountability for this disaster? In addition to the inflation, we’ve all lost roughly a third of our net worth in recent months.
It isn’t as if it were only RWNJs, libertarians, and deficit hawks screaming about inflation. Larry Summers was out in front of the problem.
Also, why do so many of the famed economists on the left feel that inflation still is merely a small nuisance, and that we have to ‘ease off the accelerator, not slam on the brakes?’ It seems likely we are going to see a recession soon, if we aren’t already in one.
Didn’t this all really get started when the Democratic governors decided to de facto shut down the Mom-and-Pop economy, and QE went into high gear? Was it even legal to close down all of those businesses? How many lives did it really save?
It’s just awful to see all of this happening, because it could have been prevented. Unfortunately, histrionics, interventionism, and failed ideas will once again likely rule the next time this sort of thing happens.
Jun 13 2022 at 9:51pm
Above target inflation ain’t great, but it doesn’t destroy a third of the country’s net worth in a few months. Not in any real sense at least.
The houses and factories are still all standing. People still have their skills and connections.
Jun 13 2022 at 9:58pm
P.S. Where are you getting the one third figure from anyway?
I guess you can round the drop of the S&P500 from its all-time peak to now to the figure of one third? (Especially if you take into account that those share prices are measured in the same USD that saw lots of inflation.)
That’s true enough, but it’s not a good measure of the net worth of the nation. The price of stocks is (commonly) a leveraged bet on those companies, thanks to debt on their balance sheet.
That magnifies any change in their fortunes.
A large part of those shares are also held by foreigners, who presumably don’t figure in this calculation?
And, of course, there’s assets like owner occupied housing, which form a big part of the aggregate national balance sheet, but don’t show up in stock prices. At least not directly.
Jun 14 2022 at 8:18am
The S&P drop is yet to even hit 25%, if I’m not mistaken. I guess I was speaking more out of frustration, as someone who invests primarily in the NASDAQ, and who is not a homeowner.
Have U.S. asset prices actually declined by 1/3? They have not, but I am inclined to believe things will continue to get worse.
Jun 13 2022 at 10:48pm
“Didn’t this all really get started when the Democratic governors decided to de facto shut down the Mom-and-Pop economy,”
Sweden’s government did not force its stores to close, and its recession was just as deep as in the other Nordic countries. The recession was mostly caused by voluntary social distancing, not government mandates.
Jun 14 2022 at 8:21am
I’m not surprised by your response, and I guess I have to concede that it’s true, but our recession was even worse, and though I may be wrong, I find it difficult to believe things would presently be this bad without the mandated closings in the U.S.
Jun 14 2022 at 8:42am
To be clear, I’m not disputing what you’re saying; it is true, and does make sense, I just am probably looking for something to blame other than the Fed.
Jun 14 2022 at 1:47pm
I certainly agree that if Covid had never come on the scene then some of these policy mistakes (fiscal, monetary) would not have occurred to the same extent. And supply problems would be much less. Of course we’d still have Ukraine.
Jun 13 2022 at 10:01pm
Scott, that’s an interesting exchange. I wonder what it says about various efficient market hypotheses?
The information in the quoted exchange was news to you (and me), but presumably it wasn’t some closely guarded insider secret. So we’d expect markets to reflect this already at the time?
Could we find evidence for or against this?
Jun 13 2022 at 10:45pm
I think the markets understood that NGDP was likely to overshoot, but perhaps did not expect such a dramatic overshoot.
Jun 14 2022 at 8:03am
Found an interesting set of coincidences.
The flu of ‘68-‘69 occurred simultaneously or right before a recession. Same with ‘57-58. And of course same with 1918. Same with Swine flu. And now Covid too.
Not all recessions cause pandemics——but it might be true pandemics all cause recessions.
Re: “FED knew” —-I really do not know if FAIT or it’s NGDP equivalent can be implemented—-or even if it works if implemented. As of now, it is an unproved hypothesis. I believe that is an accurate statement. It is a hypothesis—-and it has not been demonstrated to make accurate predictions.
As I have mentioned before, it is virtually impossible to read Powell’s 8/27/20 statement and not believe he was announcing a symmetric inflation targeting framework. He admitted that it would be flexible and not tied to a predetermined formula. I recently came to believe that was the right approach.
BUT—-if you read the statement hunting for inconsistencies, not once, when he was providing examples, did he ever use targeting lower than 2% inflation in his hypothetical examples. The point is, it was in fact vague. He referred to what he called “other make up theories” —-with no conclusion
When last Fall he stated that he never said that he would target lower “make up” inflation, it was in fact shocking. He claimed he never said it. It is impossible to trust his abilities.
One interesting observation is we have “defacto” practiced FAIT. PCE ex food and energy has had average annual inflation of 2.23 since 1985-April 2022. Range is about 0-5 for any given year. But we have never said to the world we will try to do this.
Yet we have always done it—-
Jun 14 2022 at 12:37pm
Inflation targeting averaging around 2% is less of an actual Federal Reserve policy and more of a natural economic norm in a fully developed economy. Look across the world, every single fully developed economy has averaged low inflation rates (1-5%) since the early 1980s. In some nations inflation targeting was never a goal, others pursued outright price stability (0%).
No, what likely happened is that fully developed economies have encountered the PPF and therefore slow productivity growth coupled with low population growth rates. Considering that there is a widespread tendency in the economy to provide even unproductive employees with “sympathy raises” of 1-2% no matter what, inflation should be above 0% even in a Japan-type fully developed economy.
Inflation targeting as we know it today is a non-required development of modern monetary policy. Volcker himself emphasized that the Bernanke 2% target was absolute inanity and not based on actual proven research.
Jun 14 2022 at 1:50pm
“The flu of ‘68-‘69 occurred simultaneously or right before a recession. Same with ‘57-58. And of course same with 1918. Same with Swine flu. And now Covid too.”
This is very misleading. Covid mostly occurred after the recession (which lasted 2 months.) The 1918 epidemic occurred well before the 1920-21 depression. There’s no link.
Jun 15 2022 at 9:59am
1918 did have a short recession (I never mentioned the depression of early 20s)—although many have attributed it to the end of the war, not the flu. Covid——not sure what one calls the “V” in Q2 2020—but it was simultaneous with the start of the Covid Pandemic (120k Covid deaths in Q2)
I have called it coincidence—-because I cannot know—-however, your critique does not relate to what I wrote.
Jun 15 2022 at 12:46pm
In any case, before or simultaneously with a recession is pretty meaningless, given that recessions occur on average every 4 years. For most of our history, almost every single year was either a recession or right before one.
Jun 15 2022 at 3:00pm
Not that it matters—-it was just a quirky observation—but recessions happen every 6 years on average —:-)
Jun 15 2022 at 8:19pm
The 1957-58 outbreak occurred during a recession. The 1968-69 outbreak occurred during a boom. Sorry, I don’t see a pattern.
Jun 17 2022 at 8:39am
This comment bleeds into my comment about not “knowing what is real” in your most recent essay. The following is about 1968-69.
“According to the National Bureau of Economic Research the recession lasted for 11 months, beginning in December 1969 and ending in November 1970, following an economic slump which began in 1968 and by the end of 1969 had become serious”
This is the opposite of what you stated. I have no idea which is correct—-and this is plain history.
Jun 17 2022 at 8:54am
I really have to laugh——check out this essay on JSTOR
”The Economic Crisis of 1968 and the Waning of the “American Century”—By Robert Collins. I am not trying to prove you wrong—-as my “prior” is you know what you are talking about. But is it surprising my default position is skepticism about most of what I read? And what could be more easy than to determine if there was a recession ( is “crisis” a trick word?) in 68-69?
Jun 14 2022 at 12:27pm
They believed that history had ended. That the impossible was now possible, through some perfection of monetary policy. That socio-economic objectives could be achieved through the proper mixture of monetary and fiscal stimulus. The Federal Reserve lost its grip on historical truths and entered a post-modern daydream.
More specifically, the Federal Reserve members, in their misguided pursuit of new objectives, ignored the divergence of economic trends from their forecasts. Their assumption that forward guidance and “strong talk” would make up for real monetary policy changes led them down a path of delusion.
One one hand, the next year will not be as painful as 2008 or even 1981. On the other, the damage to Fed credibility will cost the average American (and many foreigners) a significant amount of economic stability over the next decade. Monetary instability leads to financial volatility (as can be seen in the bond market today) and eventually to economic inefficiencies which tend to beget political chaos. Here’s to hoping Powell course corrects soon.
Spencer Bradley Hall
Jun 14 2022 at 5:26pm
“Mr. Hanke, predicted in these pages (WSJ) last July that year-end inflation for 2021 would “be at least 6% and possibly as high as 9%.”
“Powell cited 1965, 1984 and 1994 as examples where the FED corrected the economy without a recession.”
link: Daniel L. Thornton, Vice President and Economic Adviser: Research Division, Federal Reserve Bank of St. Louis, Working Paper Series
“Monetary Policy: Why Money Matters and Interest Rates Don’t”
Jun 14 2022 at 10:44pm
Could the FED monetary policy during 2021 have been affected by the fact that President Biden had to nominate (or not) Powell for a second term by the end of 2021?
Jun 15 2022 at 8:19pm
Jun 15 2022 at 8:12pm
WaPo June 2021:
after six months in office, White House hasn’t moved to fill an empty seat on the Fed’s seven-member board of governors, in the midst of the worst economic crisis in a decade.
Dean Baker May 2021:
It would be good for the economy if Powell were reappointed and if Biden announced this decision as soon as possible.
Biden did not reappoint no Powell until November 2021.
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