I have a new article at The Hill, which discusses various reasons why the Fed screwed up in the second half of 2021. Here’s an excerpt:
I see at least three reasons for the Fed’s policy mistake.
One was too much focus on closing the so-called “output gap” between actual real GDP and potential GDP, which is exceedingly difficult to estimate. . . .
[second] At a press conference last month, Fed Chair Jerome Powell was asked if the Fed should aim for less than 2 percent inflation after a period of excessively high inflation in order to bring the average back down to the long-term target. Powell forcefully rejected that suggestion, directly contradicting the Fed’s new AIT policy. . . .
The Fed’s sluggish response to economic overheating points to a third reason for its mistake: Officials were frightened by the market’s “taper tantrum” in 2013. As a result, they now prefer to signal policy changes very gradually.
Please read the whole thing.
READER COMMENTS
Kevin
Feb 13 2022 at 4:21pm
Many commenters on The Hill seem to think all or most of this inflation is due to price-gouging. While I’m not qualified to say whether or not this is true, I can’t help but wonder why people can’t just accept that the Fed has sort of blown it again. Most of the commenters fall into a back and forth political discourse defending or attacking either Republicans or Democrats. How much blame can we assign to fiscal policy, and the influence of the executive branch to our present inflation problems? I suspect not all that much.
Scott Sumner
Feb 13 2022 at 5:39pm
I agree that it’s silly to blame one party or another, as both parties had virtually identical fiscal and monetary policies. Biden even reappointed Powell, and Trump supported the $2000 checks to everyone even after he lost the 2020 election. Politicians have very little impact on the business cycle
And price gouging? That doesn’t even pass the laugh test. How could price gouging cause NGDP to rise at an annual rate of 14.3% in the fourth quarter?
dlr
Feb 13 2022 at 4:34pm
Your main argument resonates. But I don’t think it makes sense to describe the taper tantrum as being about inappropriate tightening. The stock market yawned. That’s not to say overall policy wasn’t too tight in 2013. But to the extent policy makers fear a repeat of the tantrum, it is more about the surprising jump in long rates amid otherwise yawning asset prices. Of course, there is no good reason to fear this for exactly the reason that the tantrum was almost exclusively relegated to bond markets. but when you think of yourself as a rate setter it’s hard not to fetishize kinky rate behavior.
Scott Sumner
Feb 13 2022 at 5:42pm
You might add 1994 as another example of a fake “bloodbath”. But I do believe there was somewhat of a negative reaction to tightening, even as overall the stock market was doing well in the 2010s for other reasons.
jj
Feb 14 2022 at 10:53am
Looking at figure 8 from the first link in your article, NGDP in 2021Q4 was 2.3% above trend. But 2020Q2 was 10% below trend. The total area below trend is much greater than the area above trend.
Is there any place for “make-up NGDP”? My instinct is no; lost production is gone forever, there’s no point working harder now to make it up in real terms. And there’s certainly no point inflating now just to get the nominal numbers up.
Scott Sumner
Feb 14 2022 at 12:05pm
Yes, I don’t think it makes sense to do a make-up in that way. It would further destabilize the economy, creating endless cycles.
Matthias
Feb 19 2022 at 7:22pm
Just as it is perfectly feasible to target ngdp levels, it’s perfectly feasible to target the level of the integral of ngdp over time.
However, if you want to do that, you should announce that kind of thing ahead of time.
Michael Sandifer
Feb 14 2022 at 6:24pm
The Fed is roughly meeting a commitment for 2% average inflation, in core PCE terms, over a bit over 30 years:
https://fred.stlouisfed.org/graph/fredgraph.png?g=M5eI
Of course, the Fed doesn’t have a 2% average inflation target. It has a “flexible” average inflation target over an unspecified time interval, coupled with a mandate for full employment.
Arguing monetary policy is too loose based on the Fed’s stated commitment is largely nonsense. Even if you say the Fed has been too loose in the context of a 4% NGDP level target, forgetting about the Fed’s stated commitment, the choice of 4% is a matter of discretion. One could easily argue for a somewhat lower or higher NGDPLT.
I think more humility before the market is needed here. Current 5 year inflation breakeven is around 2.5%. One can make a reasonable argument that monetary policy is a bit loose, though it’s not how I see it. But, to argue it’s a big deal at this point is silly.
Scott Sumner
Feb 14 2022 at 6:48pm
“The Fed is roughly meeting a commitment for 2% average inflation, in core PCE terms, over a bit over 30 years:”
Yes, but there were some bad stretches of monetary policy over that period of time. We are in one right now.
Michael Sandifer
Feb 14 2022 at 8:13pm
I was actually referring to the 30 year breakeven, which is obviously forward-looking. By that metric, the Fed is close to meeting an expected 2% average inflation rate over the next 30 years.
My point was that the Fed’s mandate is so vague, that this whole line of thought is pointless when the 10 year inflation breakeven is just over 2% in PCE terms.
Why should anyone care much?
Arguing for a more specific AIT commitment is one thing, but if you’re going to argue for a specific commitment, why not argue for your preferred NGDPLT?
Scott Sumner
Feb 15 2022 at 12:01pm
“Why should anyone care much?”
Because unstable monetary policy leads to recessions.
Michael Sandifer
Feb 15 2022 at 5:06pm
Acknowledged, but inflation is at most less than 100 basis points above where it should be, over ten years. This isn’t the 1970s.
Personally, I’m with Beckworth. If you think the Fed has overshot a bit, fine. But the should mostly be congratulated for performing better than any other FOMC in history in a very difficult time.
It’s easy to throw stones. It’s much harder to be a man(person, for the woke), in the arena.
Mark Brophy
Feb 14 2022 at 7:01pm
The problem is that the Fed has foolishly rejected the “quantity theory of money.”
According to the quantity theory of money, if the amount of money in an economy doubles, all else equal, price levels will also double. This means that the consumer will pay twice as much for the same amount of goods and services. This increase in price levels will eventually result in a rising inflation level; inflation is a measure of the rate of rising prices of goods and services in an economy.
The same forces that influence the supply and demand of any commodity also influence the supply and demand of money: an increase in the supply of money decreases the marginal value of money–in other words, when the money supply increases, but with all else being equal or ceteris paribus, the buying capacity of one unit of currency decreases. As a way of adjusting for this decrease in money’s marginal value, the prices of goods and services rises; this results in a higher inflation level.
https://www.investopedia.com/insights/what-is-the-quantity-theory-of-money/
Matthias
Feb 19 2022 at 7:27pm
The quantity theory of money is trivially true, if you take its central equation not as a statement, but as the definition of velocity of money.
The question then becomes whether velocity is at all stable.
Comments are closed.