Pressures on the Fed

September 1st, 2015 at 11:09 am

There are so many interesting threads in this Bin Appelbaum piece about the various pressures on the Fed right now, I’m not sure where to start!

Re their interest rate liftoff, there’s a lot of angst around what’s likely to be a tiny move—25 basis points. Whussup with that?

Economist Alan Blinder, a former Fed vice-chair his-own-self, put it this way: “There shouldn’t be this intense interest in a quarter-point increase, and there shouldn’t be this intense interest in whether it comes in September or December.”

Certainly a fair point, even more so given that everyone believes its coming in one of those months (I just saw Moody’s report saying if not at the Sept meeting, then at the October one).

But I thought Josh Bivens hit me with a compelling answer when I put this question to him the other day:

Bernstein: Do you really think it would make that much of a difference if they just bumped the Fed funds rate up 25 basis points and left it there for a while?

Bivens: No, my best guess for that is probably not. That probably wouldn’t do all that much to slow the economy, but I don’t think the economy needs to be slowed! You could flip that question on its head and say: If raising by 25 basis points and holding there has little impact on the economy, why do it at all? There seems to be some sort of pressure that I don’t understand about “the need to get off of zero.” I do economics, not psychology, and to me the economics say that while 25 basis points is not a big move in the wrong direction, it’s still the wrong direction!

Is there something off in the core of the Fed’s model?

Appelbaum writes that the Fed’s annual retreat this year was fraught with “…a series of academics warn[ing] policy makers that their view of inflation was oversimplified, and that their policies were less effective as a consequence.”

This is existential stuff for the Fed. I and others have long groused about the how the Phillips Curve—the historical relationship between inflation and unemployment—is an increasingly unreliable guidepost for Fed policy. One interpretation of some of the work that’s coming out on this is that Yellen and Co. are staring down at a map which no longer accurately shows the landscape of the economy they’re trying to manage.

Fed vice-chair Stan Fischer argued that “the role of labor market slack is easily overstated…”

I think slack is understated, so this caught my eye. Based on his remarks on this point, Fischer believes that since the reduction of labor market slack has not generated price pressures, there must be other dynamics pushing the other way, like the strengthening dollar. Hmmm…maybe on the price side, but there’s nothing much in the way of nominal wage growth pressures either. So it seems absolutely critical to not assume away the possibility that there’s been less slack reduction than you think. Look at the employment ratio; look at Andy Levin’s all-in slack measure—they’re still signaling a job market that is unquestionably improving but is still far from full employment.

And yes, I completely agree that the strengthening dollar is in the mix, lowering both inflation and, through the trade deficit, growth. What I don’t see is how those facts convince one that it’s necessary to liftoff sooner than later. Again, I stipulate the Blinder point re 25 basis points not being worthy of all this sturm und drang, but the point here is the if I understand him correctly, Stan’s incorrectly discounting existing slack.

Is this right: “The biggest risk for those that are less fortunate is that we would go back into recession.”

So said James Bullard, president of the St. Louis Fed, as a rationale for doing what the representatives of the less fortunate—the members of the Fed Up campaign—were decidedly asking him not to do. He’s basically saying: “we must raise soon to protect the expansion against forces that would threaten its survival.”

The problem with this framing is that what really helps those who’ve yet to benefit from the recovery is really tight, full-employment labor markets, as Dean Baker and I show here. These results are particularly notable for minorities, who have a much larger full employment multiplier re their employment and earnings opportunities than whites.

In a sense, this is the “asymmetric risk” argument that remains central: given the absence of price or wage pressures, any moves to slow the economy are more risky to workers’ well-being than are inflation or recession.

The piece suggests there’s a “disconnect between the officials and the activists” coming from both the left and right.

Not sure that’s correct. Activists on the right want “to impose new restrictions on the Fed’s conduct of monetary policy. A leading proposal would require the Fed to choose a formula for setting rates and stick with it.”

That’s far more radical than the ask from the left, which is that the FOMC at this point give more weight to the full employment side of the dual mandate than the stable prices side. At its core, that’s a substantive argument about observable movements of variables and expectations. Read any Chair Yellen speech over the past few years and you’ll hear her wrestling with precisely those questions.

I don’t see a disconnect there as much as a disagreement about many of the factors discussed above, re data trends and models.

The critique/attack from the right is a wholly different creature, an ideological one targeting the independence of the Fed in ways closer to Ayn Rand, or her namesake, Rand Paul, than actual data.

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3 comments in reply to "Pressures on the Fed"

  1. BroD says:

    Yes–thank you. And may I say that, here in Baltimore and other American cities, the impact of the flagging labor market is very much in evidence. The unrest in the streets is not just about police/community relations.


  2. jonny bakho says:

    The Fed is uncomfortable with interest rates that have been this low for so long.
    Fiscal policy has been too austere to push the economy into a zone that would call for higher rates.
    Maybe someone wants to do an experiment?
    Perhaps there are wealthy special interests with bets on when the Fed raises rates?
    They could apply direct and indirect pressure.


  3. Procopius says:

    Did you miss Stanley Fischer’s statement that we have nearly reached our “maximum employment objective?” He may have let that slip out inadvertently. I’ve been more and more persuaded that they are fully committed to a belief in Marx’s idea that capitalism depends on a large reserve army of unemployed, and that’s what is driving this.


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