Economist Andy Levin is someone whose name you’ve seen numerous times here at OTE. We’ve often cited his all-in slack measure—the total employment gap you see here, e.g.—and he and Danny Blanchflower wrote an important paper for our full employment project, linking slack, wage growth, and monetary policy. Andy was at the Fed for years, then the IMF, and he’s now an econ prof at Dartmouth.
Relative to those previous positions, Andy should have more opportunities now to weigh in on issues of interest to him and one hopes this initial commentary is a sign of what’s to come. It’s a clear, muscular argument about a critical and timely issue: what I’ve called the craze to raise at the Fed.
Andy reflects on the likely forthcoming liftoff of the federal funds rate, concluding that “the rationale for that policy judgment rests on faulty analytical assumptions about the labor market, inflation dynamics, the stance of monetary policy, and the balance of risks to the economic outlook. Consequently, initiating monetary tightening at this juncture would be a serious policy error.”
Check it out for yourself, but here I’ll underscore two points.
First, the conventional wisdom is that the Fed has been “extremely accommodative.” But when you plug current values of relevant variables into Taylor-type rules, you quickly conclude that holding the funds rate at zero is where they should be, if not above: “the Taylor (1993) rule prescribes a funds rate of 0.1 percent, exactly in line with the FOMC’s current target range of 0 to ¼ percent, and the Taylor (1999) rule prescribes a funds rate well below zero (-1.4 percent).”
(Note that Chair Yellen, if memory serves, has endorsed the ’99 rule, also pointing towards the lower target.)
That last bit suggests that faster inflation would help right now by lowering the real rate. In this regard, allow me to raise one of my own concerns here: the strengthening dollar, which, by pushing down on inflation is doing the Fed’s liftoff-work for them.
Second, Andy’s conclusion speaks to some serious head-scratching I’ve been engaging in of late re Fed policy—apparently I’m not alone:
The FOMC’s near-term strategy has become so opaque that even the most seasoned analysts can only guess what policy decisions may be forthcoming at its upcoming meetings. Moreover, the FOMC has provided no information at all (apart from the phrase “likely to be gradual”) about how its policy stance will be adjusted over time in response to evolving macroeconomic conditions. Unfortunately, such opacity is likely to exacerbate economic and financial uncertainty and hinder the effectiveness of monetary policy in fostering the goals of maximum employment and price stability. Therefore, it is imperative for the FOMC to formulate a systematic monetary policy strategy and to explain that strategy clearly in its public communications.