A Note on the Federal Reserve Dissenters’ Supply-Side Logic

I made the case that liberals should engage monetary policy more directly in the New Republic today with Why Liberals Should Join Conservatives’ Fed-Bashing Fun.

I want people to pay special attention to the Evans Rule, from Chicago Fed President Charles Evans’ fantastic speech The Fed’s Dual Mandate: Responsibilities and Challenges Facing U.S. Monetary Policy.  The Federal Reserve could simply state that they will keep interest rates at zero and tolerate 3 percent average inflation until unemployment was down to 7 percent.  I’d consider going further and announcing a targeted transition to a permanent 4% inflation target, while keeping rates near zero until unemployment was at least 6.5%.  But these are the areas where liberals need to focus their monetary energy.

Because Operation Twist won’t cut it, especially with the housing market a complete mess.  And even considering this, Operation Twist had three dissenting votes – Fed Presidents Richard Fisher, Narayana Kocherlakota and Charles Plosser.

Having a map of the demand-and-supply sides of the policy debates is crucial to analyzing their arguments, and we’ll allude to this map throughout this post.  For the dissenting arguments aren’t in the demand side but instead in the supply side.  Instead of thinking we have a demand problem but that monetary policy is ineffectual in this environment – an opinion held by many people – the arguments they use to tell the public about why they are against future monetary policy uses the language of the supply-side.

We don’t know yet exactly why they dissented this time, but we have clues from previous statements.  For Fisher, this is from the August 20th FOMC meeting (my bold for the following three):

Voting against this action: Richard W. Fisher, Narayana Kocherlakota, and Charles I. Plosser….Mr. Fisher discussed the fragility of the U.S. economy but felt that it was chiefly nonmonetary factors, such as uncertainty about fiscal and regulatory initiatives, that were restraining domestic capital expenditures, job creation, and economic growth. He was concerned both that the Committee did not have enough information to be specific on the time interval over which it expected low rates to be maintained, and that, were it to do so, the Committee risked appearing overly responsive to the recent financial market volatility….

He said similar in an August 17th speech, applauding Texas’ job growth. “Those with the capacity to hire American workers―small businesses as well as large, publicly traded or private―are immobilized. Not because they lack entrepreneurial zeal or do not wish to grow; not because they can’t access cheap and available credit. Rather, they simply cannot budget or manage for the uncertainty of fiscal and regulatory policy.”  That’s the “government-induced uncertainty” circle.

For Kocherlakota, we have his big paper Labor Markets and Monetary Policy, which states:

There are good reasons to believe that expected after-tax productivity p fell. Over the past three years, the U.S. economy has experienced large increases in the federal budget deficits, contributing substantially to the overall federal debt. In addition, many states and municipalities are facing budgetary challenges. It is natural for firms to expect that these budget challenges at all levels of government may be met at least partially by future increases in tax rates. Both in the model and in reality, firms know that hiring a worker is a multiyear commitment, and so what matters for that decision is productivity, net of taxes, over the medium term of the next several years. If firms expect to face higher taxes in this time frame, then their measure of p has fallen.

What about the utility that a person derives from not working? In response to the recession, the federal government extended the duration of unemployment insurance benefits. Thus, it is plausible that z has risen in the past three years. This increase—in and of itself—means that firms must offer higher wages….In this scenario, nominal rigidities are playing a much less important role in suppressing the creation of job openings. Correspondingly, monetary policy should be considerably less accommodative…However, if (p−z) has fallen by 0.15, then the implied u* is 8.7 percent. This is indeed a wide range of possibilities.

So the big things in play are government-induced uncertainty in terms of budgetary challenges and future tax increases along with unemployment insurance. In Kocherlakota’s models, the natural rate of unemployment might be 8.7% or higher, so in Narayana’s mind he has gotten us to Full Employment.  Congrats!

Mind you, the models he uses don’t even really have a place for insufficient demand to be part of the story, which is kind of a problem.  But either way, he’s in the overlap of “government-induced uncertainty” and “productivity.”

What about Plosser? Here’s a February 2011 interview with the Wall Street Journal:

Mr. Plosser’s answer is unequivocal: This mess was caused by over-investment in housing, and bringing down unemployment will be a gradual process. “You can’t change the carpenter into a nurse easily, and you can’t change the mortgage broker into a computer expert in a manufacturing plant very easily. Eventually that stuff will sort itself out. People will be retrained and they’ll find jobs in other industries. But monetary policy can’t retrain people. Monetary policy can’t fix those problems.”

Scott Sumner has devastated the argument that this is about unemployed carpenters with a passing glance at the data, and as far as I can see Plosser has offered little additional data on this matter.  And again, even if a “natural” rate of unemployment has jumped up to 6% or 7%, there’s still millions of people who are unemployed where policy can make a difference.  But either way, he’s operating from the “labor productivity” circle in the Venn diagram.

So when we look at the three dissenters they don’t have a demand story where monetary policy can’t work.  They have a story where things would be fine if the government just got out of the way and stopped trying to regulate the financial sector, focused on balancing the budget immediately and also stopped preventing people from moving to new careers by giving them unemployment insurance and hope that unemployment will come down anytime soon.

How did these people ever end up being some of the most important people in the country went it comes to whether or not our country will leave the Great Recession and get back to Full Employment?

It would have been great if Charles Evans had dissented on behalf of the unemployed.  It is important for the public to understand that the dissenters aren’t balancing out a Fed that is too active, but instead holding a Fed that could be setting more aggressive expectations in check.  They have their biases and are seeking out whatever stories and data will fit into it, and their biases end up being against trying to close the unemployment gap.  And thus our unemployment crisis continues on.

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11 Responses to A Note on the Federal Reserve Dissenters’ Supply-Side Logic

  1. Taryn H. says:

    I wanted to comment over at TNR, but I couldn’t get signed in and it was a big headache. Anyway, I really wanted to comment on your argument that the Left should be pushing for monetary stimulus. Three things:

    1) There is disagreement among people who really understand the issue as to whether the Fed actually could produce inflation if they wanted to – Richard Koo argues they can’t; Krugman argues they can, but only by effecting expectations; and then, people like Rogoff, seem to think it would be a snap (just print money and, voila, inflation).
    2) Those liberals that have supported inflation-producing monetary stimulus have taken sh*t for it – like when Yglesias suggested inflation targeting, no one really considered the substance and it turned into a big discussion of neoliberalism.
    3) Here is Matt Taibbi (citing the UK Guardian) arguing that it’s obvious that QE increases wealth disparity: http://www.rollingstone.com/politics/blogs/taibblog/rick-perry-vs-ben-bernanke-round-one-20110816

    So, I’m really not even sure what to make of the whole monetary stimulus project. When in doubt, I trust Krugman, but even he says things like “it must be effective at the margins.” Well, what exactly does that mean?

    So, it would be helpful to have something that gathers all the information on whether it can be effective and, also, tackling the Taibbi argument (which wasn’t really an argument – it was really just a statement of obviousness, even though I can’t think of anything less obvious than the effects of monetary policy when you’re up against the zero lower bound)..

  2. David Wiczer says:

    I agree with Taryn to question how much inflation the Fed can produce and (paradoxically) this becomes an issue when you’re wedded to the New Keynesian-style gap model. Right? These things, say there’s a relationship between percent deviation of output from trend and the percent deviation of inflation. Then there’s a money demand that’s working on the liquidity demand for money, but if there’re no goods to buy then one doesn’t demand so much money to buy them. So you’ve got a directionality problem there: slow output drags down inflation.
    I’m definitely not an expert on these models, but the simple “print money -> price goes up” misses that prices are equilibrium objects and if you put in some frictions you can end up with equilibria that don’t have that exact relationship. It’s just that caveat by which most of your models that enable policy work.
    It’s got to be more complex then the “helicopter” strategy.

  3. Dan Kervick says:

    The Federal Reserve could simply state that they will keep interest rates at zero and tolerate 3 percent average inflation until unemployment was down to 7 percent.

    The monetarist camp in the liberal debate about monetary policy has gotten really bad about explaining exactly what it is trying to accomplish with the policies it advocates, or the mechanisms by which it seeks to accomplish them. They seem to have an aversion to concrete real-world mechanisms, and treat the economic world as though it’s some kind of human thermodynamics, based on law-like relations among a few variables. I think a lot of that textbook thinking has turned out to be pure crap.

    Both actual inflation and expectations of inflation have a host of economic consequences, affecting different kinds of economic agents in different ways. I think its crazy to be relying on crude Phillips curve thinking – inflation goes up; unemployment goes down – to address our problems in some serious way. Most of these monetary manipulations seem to do nothing more than affect betting patterns among bond, stock and commodities traders, but have little concrete influence on how real economy businesses do their business or how consumers and workers behave.

    I’m not going to be joining in with this call for more Fed activism. Progressives have wasted an enormous amount of political and intellectual energy arguing about monetarist pseudo-solutions based on what appear to me to be dramatically exaggerated evaluations of the impact of Fed policies and pronouncements on the real economy.

  4. ezra abrams says:

    As a scientist, this people are not investing because of uncertainty drives me nuts, because you would think, with all the econ grad students and sociology grad students and poli sci grad students, at least one of them would have taken six months,and a clipboard, and walked around and talked to a few biz owners.
    I mean, isn’t that the way you do science ?
    I don’t blame the GOP wackos for their nonsense; after all, their goal is an economy where 90% of us work as butlers and gardeners on their estates; by definition, honesty, etc are not needed.

    I blame the “liberal” econ people: where the H*ll are you !! I see you writing blogs, you got lots of time to waste flying to conferences and arguing about the minutiea of diff macro models, but why on earth don’t you have time to do something usefull, like find out what people actually think ?
    seriously, why ? I mean, I was a program manager at NSF or wherever it is that grad student stipends come from, I’d be all over a proposal for this; gotta be better then yet another paper on math of models….

  5. From your latest New Republic article:
    “If the Federal Reserve were allowed to deploy its credibility, higher inflation would take care of several of the major problems that are currently impacting our economy.”
    Simple question: What the hell are you talking about when you say the Fed has “credibility”? Did Alan Greenspan not drop interest rates to unprecedented lows following the dot-com bust (which he created by lowering rates in the 90’s) which in turn fueled the housing bubble? The CPI is running at 3.8% already. The three month annualized money supply growth rate of M2 is growing at 23.3%.

    Where, pray tell, is this so called “credibility”?

    Better question: Why should the left support Fed induced inflation when the newly created “money” hits the 20 primary dealers first? I thought the left didn’t like supply side economics?

  6. Dan Kervick says:

    ezra abrams is spot-on in his criticism.

    Economics is primarily a practical art, not a theoretical science. Economists who venture into giving policy advice need to start thinking of themselves more like civil engineers or city managers, and less like natural scientists. If you run the city’s water works, it helps to know Boyle’s Law. But that law doesn’t take you very far. Some of economists I read in the blogosphere are like folks who are saying that the problem with the broken water system is that there is a deficiency of “aggregate pressure” or “mean temperature”, but have never actually seen and worked any of the piping and valves in the systems that actually exist, and so have no idea what possible mechanisms to employ, and don’t have a vivid understanding of how the aggregate quantities are related to concrete phenomena.

  7. Great post and comments from everyone

    1. I agree with MIke that the Fed dissenters are sadly nothing but pure hacks for talking about “gov induced uncertainty” and “excessive unemployment insurance”. They’re just picking their extreme biases and then just stretching for whatever data they can find

    2. However, I share Dan, Dave, Ezra and Tayrn in being highly skeptical that QE and other forms of monetary stim are the answer. Matt Taibbi and commenter James (above) has correctly noted that it disproportionately benefits the Primary dealers, at least in the short run, especially if the Fed continues to pays IOR (Interest on Reserves)

    3. Let’s not forget that QE is NOT a “left-leaning” or “Keynesian” policy, it’s a right-leaning monetarist Friedmanite policy. Ironically, the most ardent contemporary critiques come from the ‘hard money’ US right, which has now become mainstream at the conservative grassroots level

    4. I’m surprised that few on the US center-left notice that QE is one of the few policies where Paul Krugman and Joe Stiglitz disagree! Stiglitz believes it causes “chaos” in the financial markets by producing financial asset price inflation / volatility without benefiting the real economy

    5. Here’s Yves Smith taking down Brad Delong, and the entire Neo-Keynesian/NeoClassical Synthesis on “Liquidity Traps” and the Keynes-Hicks model that it is based on. Apparently Keynes himself did NOT support the model, and Hicks himself eventually recanted


    While i have mixed feelings on the issue of QE/Operation Twist/inflation targeting, my tendency is remain highly skeptical, largely because I don’t see a clear mechanism that ends up creating WAGE Inflation, which is the type of inflation we actually need. Short of that, if the only thing monetary stim creates is liquidity induced speculative asset price inflation/volatility (perhaps due to our overly-financialized economy) , than I believe it does more harm than good. Creating another asset bubble in hopes that the “wealth effect” will induce people to spend more seems like a really crude and inefficient way to address demand side weakness.
    Perhaps what liberals (and frankly, everyone) should be focusing on with regards to Monetary policy is less about the level of stimulus, and more about the TRANSMISSION MECHANISM for proper delivery of the stimulus .

    Well, this turned out to be longer than I expected! I should write a blog post expanding my thoughts on the various intellectual “fault-lines” in this debate

    • fresno dan says:

      Very good points. Why exactly do people believe that most people, and in ever increasing proportions, with stagnant income for 30 years will somehow have their real purchasing power increased with inflation (is that the point of inflation – lower debt so people have more demand)?
      Their debts (home mortgage) will go down in real terms? Maybe…but what about the total lack of evidence of any increased wages while paying much more for gas, utilities, health care, and food. And they will default. Perhaps they will have more discretionary income while living in an abandoned refrigerator.
      they will however, be able to buy more Ipads…

  8. David Wiczer says:

    Re: Ezra and Dan.
    In defense of myself and my fellow graduate students in economics. There are lots of business sentiment surveys out there. The Conference Board has one. Several of the Feds have them (Philly, Dallas) and there are these purchasing manager surveys, all of which as what they plan to do an why they plan to do it. Lots of grads (and even real researchers) use this data.

    However, the profession has a long standing belief (back to Milton Friedman, who was adamant on the point) that you can’t trust people’s statements, only their actions. You suggest a really tough question: “why aren’t you, business owner, hiring or investing?” Worse, it is unlikely to yield useful quantitative data, and certainly economics should not become less quantitative. Instead you ask a more pointed question like, “are you holding back because of ____ “, which is problematic because you’ve now framed their thinking and will get a biased result.

    And besides, our advisers are harsh enough critics, take it easy!

  9. I’d make the names left to right correspond to the faces left to right. Kocherlakota is on the right not in the center (I’m talking page layout not ideology).

    Sumner is not the only person to take a cursory look at the data. Kocherlakota used to argue that the problem is unemployed construction workers and Krugman (among, I’m sure, many others) proved him wrong with a cursory look at the data.

    Kocherlakota learned that lessson. But he still has the same conclusion. Your case that he is starting from the conclusion is strongly supported by the fact that he made new arguments for the same conclusion when his old arguments were refuted by a cursory look at the data.

    I’d note that he has some new trouble with another cursory look at the data (see Krugman again), since Government spending has not been anomalous (Federal up state and local down). The increased deficits are almost entirely due to reduced revenue. Of course his argument also workds for the effects of a sudden decline in revenue so long as the decline is not based on reduced payroll taxes or income taxes on marginally employable workers. But then he would have predicted a spike in unemployment in 2001. That didn’t happen (although I admit that employment growth was slow after the Bush tax cuts as Kocherlakota must have predicted if he is honest, but I don’t recall that prediction). As for unemployment insurance, there is no shortage of unemployed people who are not receiving unemployment insurance).

    Other points you might have added. The Texan unemployment rate is 8.5% not far below the national average. Texas has tighter regulation of mortgage lending than the hardest hit states (yep nanny state Texas did better than free market California). And small businessmen are asked what is their main problem. A huge fraction say dmeand and a tiny fraction say regulations. Maybe they are lying and Fischer is not totally out of touch with reality. But that’s not the way to bet.

  10. Pingback: Forgiving Student Loan Debt: The Stimulus Nobody’s Talking About

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