Wonky Fed Post (hip waders advised)

The Fed’s been doing some pretty nontraditional things recently under Ben Bernanke.  A lot of this was not unexpected given his record of academic research on the subject of the Fed trying to be more public about its actions and the role of Quantitative Easing in Japan’s lost decade recovery.  I thought I’d put a few things up about both.  I’m going to have to use some monetarist jibber jabber so please ask questions if the jargon is overwhelming!  It’s easier to explain the jargon downthread than write a long run on post with explanations included.

The Roosevelt Institute held a Future of the Federal Reserve Event. Here’s video via RortyBomb of Joseph Stiglitz discussing QE2 among other Fed issues. I mentioned something yesterday down thread about the effectiveness of transmission of monetary policy through the traditional interest rate channel into the real economy and Stiglitz has a fairly succinct comment on that.   There is some debate on how much the Fed can actually do much at this point–with zero bound interest rates–to get at unemployment and even the inflation coming from higher oil and food prices.  We know it can happen, it’s just we don’t have empirical evidence under similar situations–other than from Japan–to know the degree to which stuff can happen right now.  So it could be an infinitesimally positive effect even thought it’s a positive effect.

There’s been some discussion of this on economists’ blogs since the Bernanke Presser a few days ago. Mark Thoma tweeted this critique of both him and Brad Delong on the Bernanke Presser from a monetarist’s site from blogger economist Stephen Williamson.  My first masters was in Monetary Economics so I’m well-steeped in monetarist theory.

In standard form, Mark Thoma’s heartgoes out to the unemployed, as mine does. However, Mark is much more certain than I am that the Fed can actually help these people out. Here is what Mark would have asked Ben about, if he could:

The main question I wanted to hear Bernanke answer is, given that inflation is expected to remain low, why isn’t the Fed doing more to help with the employment problem? Why not a third round of quantitative easing?


In retrospect, more aggressive action by the Fed was warranted in every instance. Perhaps this time is different — I sure hope so — but the recovery has been far too slow to be tolerable. Green shoots require more than hope, they require the nourishment, and with fiscal policy out of the picture it’s up to the Fed to provide it.

Well, the answer to the question: “Why not a third round of quantitative easing?” should be: “Because it does not do anything.” (see here). In retrospect, the Fed could not have done any more than it did, even if you think that sticky wages and prices matter in a big way. Mark may think that the level of employment is intolerable, but the Fed has to tolerate it in the same way I have to tolerate the soggy weather outside.

I wanted to put this up before I linked to Krugman’s Op-Ed today which argues that Bernanke may be unduly influenced by inflationistas and Ron Paul, of all people called “The Intimidated Fed” and that he can do more.  Because, I’m not so sure the FED can do much more or if it’s Ron Paul that’s the dragon needing slaying.  First, I think it more like that Bernanke is being influenced by two Fed Presidents sitting on the Board of Governors right now than by Ron Paul. But, I’m not a DC or FED insider so it’s pure speculation on my part.

Some background: The Fed normally takes primary responsibility for short-term economic management, using its influence over interest rates to cool the economy when it’s running too hot, which raises the threat of inflation, and to heat it up when it’s running too cold, leading to high unemployment. And the Fed has more or less explicitly indicated what it considers a Goldilocks outcome, neither too hot nor too cold: inflation at 2 percent or a bit lower, unemployment at 5 percent or a bit higher.

But Goldilocks has left the building, and shows no sign of returning soon. The Fed’s latest forecasts, unveiled at that press conference, show low inflation and high unemployment for the foreseeable future.

True, the Fed expects inflation this year to run a bit above target, but Mr. Bernanke declared (and I agree) that we’re looking at a temporary bulge from higher raw material prices; measures of underlying inflation remain well below target, and the forecast sees inflation falling sharply next year and remaining low at least through 2013.

Meanwhile, as I’ve already pointed out, unemployment — although down from its 2009 peak — remains devastatingly high. And the Fed expects only slow improvement, with unemployment at the end of 2013 expected to still be around 7 percent.

It all adds up to a clear case for more action. Yet Mr. Bernanke indicated that he has done all he’s likely to do. Why?

Second, I’m not sure Bernanke (i.e. The FED) is in a very strong position to do much that can influence the real economy right now.  The QE stuff really only shifts the FED portfolio around between long and short term debt which can influence yield curves, but, at the zero bound, there’s still a limited impact on real interest rates.  You really can’t go lower than zero in nominal terms.  Also, the FED’s bought all this crap from every one from Belgian cities to AIG to give them more liquidity and for the most part, that money’s not channeling back into the US economy in the forms of loans.  Monetary policy is never very effective when an economy is in a liquidity trap (extremely low interest rates) and its transmission channel–the way the policy gets to the real economy where GDP lurks–morphs during various economic conditions.  We’re not seeing anything resembling 20th century economic conditions.

What I mean by ’20th century economic conditions’ is  this.  We’re experiencing an incredible outflow of jobs, investment funds, lending, etc to other parts of the world where frankly, the economic outlook is much better. Plus, their cheap stuff is flooding our market here.  So, the first question to ask is whose economy is actually getting the stimulation?  China and other ASEAN+3 places are experiencing inflation and their policies as well as ours are most likely at the root. We may very well be exporting the inflation as well as the investment dollars and jobs. Second, we’ve never had interest rates so close to zero (i.e. at the zero bound).  This is still relatively new territory and we don’t have the empirical evidence to estimate the size of things like the money multiplier or the shape of the Money Demand curve changes shape around a liquidity trap.  (I warned you this would be wonky.)  A liquidity trap basically means that interest rates are so low that who ever really wants to borrow has already done so.  That means you can’t urge any more people to borrow just based on interest rate manipulation.  Again, the rate of change along demand curves means things can change by leaps and bounds or hardly at all even though the basic relationship stays positive or negative.

This brings me back to the ‘real’ sector of goods and services. We have a lot of householders who don’t feel that we’re out of a recession. There’s the psychological effect too of having lost your wealth via lower house prices and you’re still watching the high unemployment rate. Then, there’s businesses who aren’t about to expand and borrow whatever the tax rates or the interest rates because they don’t have enough customers to generate a decent, reliable cash flow. Believe it or not, it’s still customer purchases that drive businesses!

The problem at the moment is not the monetary policy.  It’s the fiscal policy.  Krugman says that “Goldilocks has left the building”.  Well, in terms of fiscal policy, the three bears never came back to the building.  We had a bit of stimulus in the Obama stimulus of 2009 that stopped some of the future hemorrhaging of federal and state functions.  That’s gone.  The rest of it was nonsensical tax cuts which we just got more of in December, 2010.   It’s not completely translating into madcap household spending because–again–see the point above. This isn’t the 20th century US economy and this wasn’t your father’s Great Depression.   People are nervous and worried, they’ve lost wealth, and they’re still madly unsure about their jobs.  Plus, they now are paying more for food and gas.  They also have less faith in the last two governments than the ever did under FDR.  I’m going to sound like a old-school Keynesian, but those animistic spirits matter!

So, I don’t think we’ve reached a point where the Fed can basically maintain a course.  This doesn’t exactly let Bernanke off the hook, believe me.  What my arguments should do is put those responsible for fiscal policy–the White House and Congress–back on the hook. We’ve had miserable fiscal policy for about 10 years now.  As a result, we’ve had two miserable recoveries and shameful job markets.  We’ve also had an explosion of exotic investments in nonstandard markets and financial institutions that have caused high risk, market instability, and incredible variation in financial returns.   The biggest thing that the Fed could do right now is push for better laws that give it better ability to regulate this mixed up set of financial institutions that we now have with their opaque, information-asymmetric riddled grab bag of financial innovations.  They need to offset the banking lobbyists who are pushing to remove what little was done in Dodd-Frank.

There’s something to be said for arguing that banking is really like a public utility and not like other types of businesses.  If we’re going to bail them all out like they’re so important to the economy they can’t fail, they we need to start regulating them in that same way with that same realization. It might be time to force lenders to lend and get them out of the business of casino-like speculation.  It’s also time for Congress and the President to go to fiscal policy school and learn what’s what about basic economics.

Just a wonky  bunch of thoughts from a bayou dwelling economist.

Oh, and if you want to read something else on the Fed’s Options, here’s one I just found: For the Fed, a Narrowing of Options.  The squeezin’ is not making the eagle grin …

This week, even as the Fed was lowering its forecast for economic growth in 2011, it was also lowering its expectations for unemployment. It had no choice. Back in January the consensus among Fed officials was that the unemployment rate would be 8.8 to 9 percent in the final quarter of 2011. It has already fallen to 8.8 percent, and the new consensus, of 8.4 to 8.7 percent, could be far too pessimistic if companies mean what they say about hiring.

23 Comments on “Wonky Fed Post (hip waders advised)”

  1. dakinikat says:

    Trump obviously needs lithium and economics lessons.


    I think he needs to learn that we can’t just put tariffs on foreign goods without massive repercussions and that the price of oil is determined in a global market … not by the president. Didn’t this guy go to school some where? and where’s the copy of his SAT scores and transcript of grades, then? Okay, he went to Fordham an and he went to Wharton and he earned a degree in economics … want I want to know is why he appears to have forgotten everything? Dead skunk too tight perhaps? Or maybe it’s the lack of lithium, again …

    • dakinikat says:

      also he got a medical deferment from Vietnam … hmmm maybe he needs to come up with that one too! Oh, and his taxes and court records on all those bankruptcies!!

      • madamab says:


        I think he knows that if he really runs for President now, he’s going to have to come up with a whole lot of documentation – and NOTHING will be off-limits. I’m sure he’ll decide not to run as soon as the last episode of “The Apprentice” airs.

        I really enjoyed this post even though I am not an economist. I think I got the basic point, which is here:

        So, I don’t think we’ve reached a point where the Fed can basically maintain a course. This doesn’t exactly let Bernanke off the hook, believe me. What my arguments should do is put those responsible for fiscal policy–the White House and Congress–back on the hook. We’ve had miserable fiscal policy for about 10 years now. As a result, we’ve had two miserable recoveries and shameful job markets. We’ve also had an explosion of exotic investments in nonstandard markets and financial institutions that have caused high risk, market instability, and incredible variation in financial returns. The biggest thing that the Fed could do right now is push for better laws that give it better ability to regulate this mixed up set of financial institutions that we now have with their opaque, information-asymmetric riddled grab bag of financial innovations. They need to offset the banking lobbyists who are pushing to remove what little was done in Dodd-Frank.

        It seems like the D.C. solution to everything these days is for the Fed to cut interest rates to avoid inflation. Since that approach has failed to “magically” create jobs, and interest rates are pretty much as low as possible now, it makes sense that the Fed should do as you suggest and turn its efforts elsewhere, towards regulation. I know Ron Paul and other deregulation acolytes will have an aneurysm, but really how wrong does someone have to be before you stop listening to him?

      • dakinikat says:

        evidently the Republican philosophy is that if you repeat lies frequently enough they become truths …

      • dakinikat says:

        republicans don’t like him either …

        Former Rep. Guy Molinari (R-N.Y.) doesn’t want real estate mogul Donald Trump in the race for president.

        The Staten Island Republican, who backed former New York City Mayor Rudy Giuliani in the 2008 race, told the New York Observer Trump “is not qualified” to be president.

        He’s “a son of a b—h, and you can quote me on that,” Molinari told the newspaper. He also predicted Trump would ultimately pass on a presidential bid.

      • bostonboomer says:

        I want to see Trump’s college transcripts!

      • dakinikat says:

        I want Trump to prove he didn’t have a sex change!!!

      • Branjor says:

        A sex change?

        • dakinikat says:

          yes, and I ‘d like for him to prove that he’s not inhabited by demons or been abducted by aliens while he’s at it … I want to see the documents.

      • madamab says:

        I want Trump to reveal the name of his hairdresser!

  2. dakinikat says:

    Here’s a funny graph from Matty Yglesias:


    The job market sucks because, Honey !! we’ve shrunk the economy

    That gap is the reason we’re doing FINE at a low level instead of at a high level. And the prediction of a gap is a prediction, but it’s also a statement of policy. To get higher NGDP you need some combination of higher real GDP and higher inflation. Now if magical productivity elves appear on the planet earth, possibly we can surprise the forecast and close the gap 100 percent through higher real growth and prove the forecast wrong. But a plausible path toward higher nominal growth entails a mix of real growth and inflation. And the Fed seems to be making it clear that they won’t tolerate any further inflation. Closing the gap with 70% real growth and 30% inflation sounds great to me—that’s a lot of extra real growth—but it sounds bad to the Fed because it’s a bit more inflation.

    And not to put all the blame on Ben Bernanke’s shoulders, I don’t see a ton of indications that the Obama administration or Harry Reid or John Boehner or Mitch McConnell or Nancy Pelosi has a huge problem with this. Certainly nobody’s talking about it, nobody’s recess appointing anyone, and the only people putting political pressure on the Fed are hard money cranks like Paul Ryan and Tim Pawlenty.

  3. fiscalliberal says:

    Wow – good post. Lot to read and absorb. That said, we seem to be in a situation like the Japan lost decade. Doing similar things and getting non movement in the economy. We need a lot more than what we have had.

    I think in his book “Return of Depression Economic” Krugman postulates that they needed to introduce inflation. The technical reasons were complex, but I explain it this way. If people think inflation is coming, they well spend before the cost gets higher.

    I suspect the situation is much more complex today, but wonder if we are in a lost decade until inflation creeps in. I wonder what Mankiew and Goolsbe are thinking nowdays. Obama does not have much economics background in Monetary vs Fiscal and is totally dependent on what he is being told. His actions to date seem to be very timid which are the sign of someone uncertain of what to do

  4. CinSC says:

    If and when the employment numbers do return to “normal” , there’s still the issue that folks are working for far less dollars and benefits than in the recent past. The whole “quality” of new jobs created doesn’t seem to figure in to many of these equations and it is a huge part of the unease that families are feeling which you so well described. Really great food for thought in this post and not too wonky. 🙂

    • dakinikat says:

      thanks on both of those accounts … I’m really worried that it will take a decade to get back to where we won’t be off the long run GDP trend. It’s already been like 4 years and we’re not closing very fast. We’ve got very normal GDP growth for a fully industrialized nation. It’s going to take a miracle at this point.

    • madamab says:

      Excellent point, CinSC. Wages have essentially been flat for the past three decades. According to Robert Reich (I have to find that link), we dealt with flat wages first by the entry of women into the workforce, which produced two-income households. When that wasn’t enough, people started using the housing market as a way of earning big chunks of money, and borrowing on our equity when other loans wouldn’t have been so easy to get. Then came the crash of 2008, and the problems of flat wages, terrible benefits, retirement plans that are subject to the whims of the stock market, and unaffordable housing became too difficult to disguise any more.

      Now that the unions have been weakened almost to non-existence, workers are fairly helpless to do much about it. Unless we find a way to get past the sociopathy of our ruling class and get some decent public servants in Washington, we are truly f*cked.

    • dakinikat says:

      Nope. Just read that. He–and it’s Jon Walker not DDay–obviously doesn’t know of what he speaks. The research on central banks from all over the world completely debunks what he has to say. He’s not speaking from any knowledge, that’s for certain.

      • dakinikat says:

        “The Fed is audited. It’s audited continually. The NY Fed is audited by Price Waterhouse. All the fed branches are audited by independent FED auditors. Auditing monetary policy as it happens would be a disaster. It could be totally offset and completely abused by Wall Street. Every single piece of academic literature on central banks around the world says that what you’re suggesting is a bad idea. You should do some research on the topic before suggesting such a thing.”

        I just left that comment. The people that suggest these things have no idea of what they speak.

    • dakinikat says:

      eesh, the threads overrun by Paultards … it’s the first presidential trolls of the season!!!

      You know, their hero Hayek consulted for Argentina back in the day it was a tinpot dictatorship. That Hayek sure loved him some fascists.

  5. dakinikat says:

    “Operations at each Federal Reserve Bank also are subject to review by the Government Accountability Office (GAO), the audit arm of the U.S. Congress. However, GAO auditors are restricted by law from reviewing monetary policy operations and transactions carried out by the Federal Reserve on behalf of foreign central banks. This restriction was imposed by Congress to assure the independence of the Federal Reserve from political influence.”