I am in the process of a project to go over the FOMC minutes from the later part of the Greenspan era to present to get a better idea of the decision processes involved in monetary policy and size up the differences between the Greenspan Fed and the Bernanke Fed. This post doesn’t reflect the finished product, but rather to bring up some questions that came to mind. While I think that Scott Sumner and others of like opinion are probably correct in a technical sense about NGDP level targeting, there are parts of the broader psychological element of markets and economics that seem to be somewhat independent of monetary mechanics.
For the technical stuff, here’s a list of things that I believe did and do matter:
The technical aspect of the ZLB confused nearly everyone. The conclusion that using a monetary policy framework that communicates via interest rate setting is mistake for that particular reason appears to be rational given the kind of market mayhem that results when reaching the ZLB. It would have been best to avoid arriving at the ZLB even at the cost of a period of uncertainty around inflation to retain the ability to communicate in a way people understand. Since it did happen, however, we need something else that is easier for market participants to understand than nebulous Fed-speak and talking down the markets to control inflation when we need a recovery doesn’t appear to be appropriate.
IOR poses a problem because it negates the automatic opportunity cost of holding M2 at low effective FF rates and has contributed to confusion regarding interpretation of the resulting expansion. Whether it matters in the thick of a financial system collapse is part of making a judgment of appropriateness of this that I will have to leave up to those who know more about reserve banking than I do because there’s a trade off involved for nearly everything that I may not see in this case. But, as I understand it, there doesn’t appear to be any economic benefit from IOR while there are negative effects that haven’t any compensation except with Operation Twist. We’ve been told that OT is accommodative perhaps because it has, at least for now, provided an opportunity cost to holding M2 after IOR removed it. It would have been better to scrap IOR and try again with a better plan to avoid creating unnecessary distortion in the Treasury market and complexity in understanding what’s going on with base money. OT isn’t good enough because almost no one understands what it means. Does OT mean the Fed intends for the expansion of M2, either all or in part, to be permanent or not? It might but no one has said that, and nothing would say it better than eliminating IOR or setting the rate to zero.
What people believe about structural and political issues does matter, and it involves the psyche of FOMC members as well.
When going over the FOMC minutes that discussed developments of the period running up to the crisis in the housing market, I noticed that most of the concerns expressed in the meetings were of structural nature. It doesn’t appear that these things mattered to the Fed so much that they were economic problems in themselves, but they mattered to the extent of understanding the steps the Fed should take to influence the outcome consistent with its interpretation of its mandates.
Some of the issues raised were things like the rising cost of healthcare affecting labor costs, the price of energy passing through to core inflation, excess speculation in housing in some local areas, and anticipated fiscal tightening being in question. Only one of those things has been solved with recession and it is doubtful that changing the underlying policy framework will solve the others or make them less relevant to the question of whether the Fed can meet any statutory mandate at all. And that matters to the Fed.
The political situation also matters. I have only anecdotal evidence as most of the SMB people I know are Republicans or are politically independent with a strong sense of economic libertarianism. The financial crisis was bad enough to leave people wondering what would happen next on a very grand scale and I don’t believe Obama helped matters with his radicalism and ill defined plans for government intervention. It helped some to have gridlock in Congress after 2010, but that did not render him harmless. I have recollections of Obama’s union thugs and political cronies harassing financial and other corporate executives that hasn’t let up, and I don’t suppose these kinds of things leave the executives in the mood to be cooperative in helping Obama preserve his Presidency by taking the necessary risks to get us into a robust recovery. Economists can present all the comparative data from one recession to the next as they please, but not all political situations are alike, and Obama is no Franklin D. Roosevelt. Roosevelt at least expanded government with class, while I truly believe Obama did it with a sense of retribution and little care regarding whether actions being taken were helping or hurting. Obama is the king of the angry mob; and there is room to doubt that the Fed can fully overcome his negative influence and meet its mandates. I think the Fed has been unnecessarily hesitant in trying to help the situation, likely to the point of criminal negligence, but I don’t know all of the factors going into the decisions that have been made.
Given what I know so far here is my assessment of the current situation:
Fed blunders in 2007-8 created the crisis and started a political snowball of woe running down the hill.
Changing the monetary policy framework is likely necessary to put the FOMC on a better footing to have more effective influence over economic outcomes. I somewhat agree that it isn’t a panacea given the political situation and resulting pessimism, but that is no excuse for the Fed to not try to put a dent in the problem with monetary action.
The recent market rally in the US isn’t wholly related to Draghi and the potential of ECB action. While I believe that the problems in Europe represent an element of pessimism here in the US, the Draghi proposal doesn’t do anything until a sovereign has asked for help from the ESFS/ESM and so I think at least a portion of the rally is related to the possible outcome of the coming elections and a widespread belief about Obama’s effectiveness as a leader. What we might be seeing in the rally are bets that Obama is toast and what happens here in the US does have some impact throughout the world. Obama might as well be ground zero for the Great Recession and I don’t believe we can do much better than muddling through until he is gone, at least as a first major step toward recovery.