Over at Bloomberg, Clive Crook suggests that monetary policy does not deserve all of the blame for the inflation overshoot:
The Fed’s fragile independence precludes it from challenging Congress and the administration over appropriate fiscal policy. For the same reason, it can’t be seen as directly countermanding fiscal policy with interest-rate changes, much as it might sometimes wish to. Tweak the monetary-policy framework by all means — but it isn’t the main problem.
In my view, the “same reason” suggests that the Fed must engage in “countermanding fiscal policy.” Indeed, Congress has given the Fed a mandate to countermand bad fiscal policy. They are breaking the law if they refuse to do so.
The Fed’s mandate includes stable prices, high employment and moderate long term interest rates. That’s the job that Congress has instructed the Fed to do. There is nothing in the Fed’s mandate about assisting fiscal policy. If the Fed believes that fiscal stimulus is likely to lead to a level of spending in excess of what is required for stable prices and high employment, then it must tighten monetary policy to offset the effects of the fiscal stimulus. When asked, numerous Fed officials have suggested that this is exactly how they approach their job.
If it really were true that Congress and the Fed worked together to produce stable prices and high employment, then the Fed would be well advised to challenge Congressional decisions on fiscal policy. Crook is right that it is not appropriate for the Fed to challenge Congress on fiscal policy—these are completely independent policymakers. And for exactly the same reason the Fed must do whatever it takes to achieve its Congressional mandate of stable prices and high employment, even if doing so requires a rise in interest rates during a period of fiscal stimulus.
I would also challenge the implicit assumption that the Congressional moves were primarily motivated by macroeconomic considerations. By 2021, the economy was recovering very rapidly from COVID, much faster than during 2009. The motivation for the large stimulus was mostly a mixture of three factors:
1. A desire to provide relief for people hurt by COVID.
2. The age-old desire of politicians to curry favor with the public.
3. The (incorrect) perception that interest rates would stay low for an extended period.
Notice that raising rates doesn’t prevent the stimulus from providing relief to the public; indeed the assistance goes a bit further if there is less inflation.
On the third point, keep in mind that an expansionary monetary policy tends to raise interest rates in the long run. I’ve been saying that for years, and lots of people refused to believe me. Now we see the effects.
READER COMMENTS
vince
May 30 2023 at 6:49pm
The Federal Reserve Act doesn’t make the Fed responsible for high employment. It says the Fed should maintain long run growth of monetary and credit aggregates commensurate with the economy’s potential to increase production so as to promote the goals of maximum employment … and so on.
To me, that says if money and credit are sufficiently available, the Fed has satisfied its role. Beyond that, it’s the duty of other institutions.
Scott Sumner
May 31 2023 at 12:39pm
That’s a distinction without a difference. Policy that achieves the dual mandate is “sufficient”. If not, then it’s insufficient, or excessive.
vince
May 31 2023 at 8:43pm
By policy, I assume you mean monetary policy. My point is that businesses creates jobs, not banks. If creditworthy businesses are supplied with access to credit, what more can the Fed do? If businesses don’t want to hire more, the Fed can’t make them. How much should the Fed meddle (interfere) with the market rate of interest? The extent of negative real rates of return to savers?
Scott Sumner
Jun 1 2023 at 1:37pm
Unemployment is not caused by lack of access to credit, it’s caused by the interaction of falling NGDP and sticky nominal wages. What more can the Fed do? Maintain stable NGDP growth.
vince
Jun 1 2023 at 2:21pm
The Fed isn’t responsible for sticky wages. And maintaining NGDP growth, if the business environment stunts it, may force inflation that violates the second job of the Fed: maintain long run growth of monetary and credit aggregates commensurate with the economy’s potential to increase production so as to promote the goals of … stable prices.
I’m just suggesting that too much is expected of the Fed, beyond its jurisdiction.
Scott Sumner
Jun 1 2023 at 6:58pm
“The Fed isn’t responsible for sticky wages.”
Yes, and Boeing isn’t responsible for gravity.
“And maintaining NGDP growth, if the business environment stunts it, may force inflation that violates the second job of the Fed: maintain long run growth of monetary and credit aggregates commensurate with the economy’s potential to increase production so as to promote the goals of … stable prices.”
That would be true if the Fed had a single mandate. But in fact it’s false because they have a dual mandate, and NGDP targeting is the best way to address the dual mandate.
vince
Jun 1 2023 at 9:26pm
Isn’t it true that the Fed’s main tool to raise NGDP–if the private sector had all the access to credit that it wanted and deserved but isn’t expanding–is inflation? Is inflation really the best way to get out of a stagnant economy? Let’s investigate why it’s stagnant first. For example, it could be the regulatory environment. Or it could be the legal environment. And so on.
Scott Sumner
Jun 2 2023 at 11:50am
“Isn’t it true that the Fed’s main tool to raise NGDP–if the private sector had all the access to credit that it wanted and deserved but isn’t expanding–is inflation?”
The amount of credit that the private sector wishes to create is a function of NGDP, which depends on monetary policy. It’s not a fixed amount.
On your other point, NGDP targeting causes inflation and real output to move in opposite directions, which is the point. It helps stabilize the business cycle. You are correct that monetary policy cannot address long run growth, productivity, etc.
vince
Jun 2 2023 at 1:54pm
Thanks for your replies. I’m not trying to be picky, but there’s credit spending and non-credit spending. Couldn’t NGDP be defined as the sum of both–IOW, credit is part of NGDP rather than a dependent variable based on NGDP? Maybe a better description is that they’re simultaneous equations.
Scott Sumner
Jun 3 2023 at 12:29pm
Why not both?
Thomas L Hutcheson
May 31 2023 at 4:08pm
The act establishes that the Fed is charged with macroeconomic outcomes, inflation and employment, unfortunately not making clear that it is clearance of all markets, not just the labor market. That leaves fiscal policy to stick to ITS business of promoting long term growth (provision of public good and Pigou taxation/subsidization of negative/positive externalities) and income redistribution.
vince
May 31 2023 at 8:53pm
What does it mean to be charged with employment? I don’t read “maintaining aggregates commensurate with potential production” as being charged with the unemployment rate. If the money is there to borrow, and businesses don’t want it, the problem is not the Fed.
Don Geddis
Jun 3 2023 at 2:37pm
You appear to have overlooked the phrase in the Fed’s mandate about “maximum employment”. There it is, stated explicitly.
As to your final sentence, monetary policy is not about bank lending. Credit is not important. What is instead important is the value of money (in particular, the Unit of Account). The primary monetary policy transmission mechanism is the hot potato effect, not bank lending.
vince
Jun 6 2023 at 7:08pm
“You appear to have overlooked the phrase in the Fed’s mandate about “maximum employment”. There it is, stated explicitly.”
Please refer to my first post, where I mention money and credit, and also place the maximum employment phrase in its proper context. … “so as to promote the goals” is much different than being responsible for the outcome.
Thomas Hutcheson
May 30 2023 at 8:46pm
“If the Fed believes that fiscal stimulus is likely to lead to a level of spending in excess of what is required for stable prices and high employment, then it must tighten monetary policy to offset the effects of the fiscal stimulus.”No. Each time the Fed decides on settings for its policy instruments, it does whatever in light of all factors — supply shocks, changes in animal spirits, bank deposit instability, fiscals deficits, etc. — will lead toward inflation at 2% PCE at a speed consistent with maximum employment. [This assumes that 2% has been chosed to be consistent with maximum employment.] TheFed neither “offsets” or “accommodates” fiscal policy. “Stimulus” “accommodation” is language from vulgar Keynesian thinking of fiscal policy as being (or not) an economic “stimulus.”
Or maybe “yes” if the above is what you mean.
Andre
May 31 2023 at 12:48am
“1. A desire to provide relief for people hurt by Covid.”
Spending was justified as relief for people and businesses allegedly affected by policies implemented in the response to Covid.
Relief was not targeted at people hurt by Covid.
Scott Sumner
May 31 2023 at 12:37pm
Yes, that’s what I meant. I should have been clearer.
Thomas Hutcheson
May 31 2023 at 3:56pm
Hurt by the recession, whatever the channel, no?
spencer
May 31 2023 at 9:15am
A bit of history is apropos. Under the 1951 Treasury Federal Reserve Accord, the FED discontinued all of its pegs with the result that long-term issues began to sag. The FED regained its freedom to allow market rates of interest to rise, or fall, and to allow government obligations to fall in price and thus force losses on those selling government securities.
It thus was able to reestablish some control over bank reserves and to determine somewhat both the availability and the cost of credit. The effects of raising reserve ratios could no longer be offset, without loss to the banks, by merely dumping governments’ on the open market for the Reserve banks to absorb. Nor could the banks adjust their reserve position through the open market without incurring the same consequences. This change also partially reestablished the rediscount rate as a monetary tool.
However, the FED continues to take such “support” measures as are necessary to assure success of the Treasury’s debt-management operations.
spencer
May 31 2023 at 9:42am
Contrary to Powell, never are the commercial banks intermediaries, conduits between savers and borrowers, in the savings->investment process. Money and credit creation is a system-wide process. The necessity of Covid-19’s Treasury’s debt-support operations should have been foreseen, and thereby offset, by raising reserve ratios – not by eliminating them.
As Dr. Milton Friedman pontificated in a letter from Dr. Leland Pritchard (his classmate in Chicago): From Carol A. Ledenham’s Hoover Institution archives: “I would make reserve requirements the same for time and demand deposits”. Dec. 16, 1959.
spencer
May 31 2023 at 5:15pm
In 2010, the PBOC’s RRR went to 18.5% – “to sterilize over-liquidity and get the money supply under control in order to prevent inflation or over-heating”
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