In a recent post on Econlog, Scott Sumner presents questions for which there are no answers. One of the questions is this:
“Was monetary policy too expansionary during the housing boom?” The only sensible answer is “it depends.” It’s not clear what the Fed was trying to do during this period. If we knew, we could evaluate whether the policy was too loose or too tight to achieve their policy goal.
Now that unemployment has fallen to 6.6%, it’s possible to begin to make sense of the past decade. Prior to 2008, the highest unemployment rate of the 21st century occurred in June 2003, when it reached 6.3%. Let’s examine what the US economy has done over the past 10 1/2 years:
1. NGDP has grown at almost exactly 4% per year since 2003:2.
2. The PCE price index (which the Fed targets at 2%) has grown at almost exactly 2% over the past 10 1/2 years.
Because we are currently at about the same position in the business cycle as in June 2003, I think it’s fair to say that the trend rate of RGDP growth has been about 1.9% over the past 10 years. I suspect the rate is slowing, from a bit over 1.9% prior to the crash to below 1.9% since 2008, mostly due to retiring boomers, but also the immigration crackdown.
What are we to make of the 2% inflation rate? One could argue the Fed has been successful. After all, 2% is their target. But I believe that’s wrong for 3 subtle reasons.
I don’t intend to paint too broad of a picture in criticizing the post. Scott Sumner is still very much my hero. Nevertheless, the framing of the question is a bit tricky, reminding me of a sort of negative context like ‘When did you stop beating your wife,’ because the question itself is irrelevant.
It is irrelevant for many reasons, not the least of which being that the burden of proof lies with the prosecutor, and there is no such proof that ‘easy money’ leads people to behave irresponsibility or that there is a causation relationship between ‘easy money,’ a macro phenomenon, and disturbances in any single market. It is an entirely plausible and rational expectation that under the circumstances of excess supply of money versus demand many other types of investments would be stimulated across the board, and that supply side incentives are required in order for investments to become focused in any given market.
In addition, given that it isn’t mentioned which PCE price index is being discussed, core or headline, the post isn’t specific enough to come to any conclusion one way or the other. Perhaps we’re being slipped a Mickey with interchangeable yardsticks measuring price inflation? Considering headline inflation in an attempt to determine the stance of monetary policy is misleading; and in the case of the central bank doing it, it is cheating toward the side of tight under the right set of circumstances.
One of the reasons I wished to bring this up is because the difference between core and headline inflation measures is one of the most informative and compelling pieces of information market monetarists have in explaining and illustrating the hazards of inflation targeting. I see nothing to be gained in trying to speak the language of inflation nutters to make the case for NGDP targeting while removing the most powerful case for it we have. It ends up as a confused mass of troll food, and by the time the point that NGDP grew too fast (a point that I also have a quibble with) and the Fed just slammed on the brakes, causing the mayhem of 2008-09, the people who might be persuaded to our way of thinking are lost.
I certainly hope that no one minds me saying this, but the formula for explaining market monetarism to average people, and likely other economists, is the formula that persuaded me – Sumner’s early posts explaining his concept of what caused the financial crisis – straight up. No obscurity. No translating. No watering down. Give it to ‘em raw – and NO FEEDING THE TROLLS!
dajeeps 
TravisV said:
What if we judged the Fed based on average growth of 2.0% in headline inflation. Haven’t they failed dismally at meeting even that objective?
Part of what seems to have happened is that the symmetrical inflation target has been replaced with a ceiling.
Apologies but I couldn’t resist pointing that out. I certainly agree that we should ignore inflation and focus on NGDP like a laser with level targeting.
dajeeps said:
Those are excellent points. But I think that judging the Fed by the growth in headline inflation is part of the basis of your argument that it engaged in passive tightening and committed an error of omission. I am not sure that trying to have it both ways can effectively make the case for market monetarism or NGDP LT. And that was my point.
TravisV said:
Bonnie,
Re: our brief discussion of Friedman here: https://dajeeps.wordpress.com/2014/02/01/david-beckworth-is-very-kind-perhaps-too-much-so-in-addressing-failures-of-the-bernanke-fed
Yes, you’re right that Friedman didn’t think interest rates mean much. But, like Bernanke, he still had a flawed “credit view” of the Great Depression. Like Bernanke, Friedman really did think the widespread bank failures of the Great Depression were a major contributor to the downturn.
Friedman focused too much on the supply of money and how the bank failures severely reduced the supply of money.
In contrast, Cassel and Hawtrey, and now Sumner and Glasner recognize that the actual root cause of the Great Depression was excess DEMAND for money triggered by escalating gold hoarding by the Bank of France, then the Fed, then Britain, etc. etc.
I know Sumner and Glasner have made this point about both Friedman and Bernanke exaggerating the importance of the bank failures in a number of places. Here’s one example (I’m sure there are others) of Glasner criticizing Friedman’s view of the Great Depression. Note where he says “misplaced emphasis”:
http://uneasymoney.com/2011/12/12/keynes-v-hayek-enough-already
“So Milton Friedman was considered to have been daring and original for suggesting a monetary explanation for the Great Depression and finding historical and statistical support for that explanation. Yet, on the key elements of the historical explanation, Hawtrey and Cassel either anticipated Friedman, or on the numerous issues on which Friedman did not follow Hawtrey and Cassel — in particular the international gold market as the transmitter of deflation and depression across all countries on the gold standard, the key role of the Bank of France (which Friedman denied in the Monetary History and for years afterwards only to concede the point in the mid to late 1990s), the absence of an explanation for the 1929 downturn, the misplaced emphasis on the contraction of the US money stock and the role of U.S. bank failures as a critical factor in explaining the severity of the Great Depression — Hawtrey and Cassel got it right and Friedman got it wrong.”
dajeeps said:
Point conceded
TravisV said:
Some great analysis of the incentives Bernanke operated under from 2004 to 2008:
http://www.voxeu.org/article/bernanke-theory-versus-bernanke-practice
“In a recent paper (Ball 2012) I examine Ben Bernanke’s changing views about the zero bound. It seems that most of the changes occurred over a very short time. In a speech in May 2003, Bernanke was still advocating aggressive policies such as a money-financed tax cut. In a speech in July 2003, he was much more cautious. What happened between May and July?
The obvious answer, at one level, is that Bernanke attended the Federal Open Market Committee meeting of June 24. At that meeting, the Committee heard a briefing on policy at the zero bound prepared by the Board’s Division of Monetary Affairs and presented by its director, Vincent Reinhart. The policy options that Reinhart emphasised were close to those that the Fed has actually implemented since 2008; Reinhart either rejected or ignored the more aggressive policies that Bernanke had previously advocated. In the discussion that followed, Chairman Greenspan and other Committee members generally supported Reinhart’s views.
Bernanke spoke toward the end of the meeting, and he joined the consensus supporting Reinhart. The meeting’s impact is clear from Bernanke’s July speech, in which he mostly echoed Reinhart’s proposals. In January 2004, Bernanke and Reinhart co-authored a paper that closely followed Reinhart’s reasoning at the June meeting. Since the US hit the zero bound, the Fed has implemented the proposals in the Bernanke-Reinhart paper.”
http://www.slate.com/blogs/moneybox/2012/02/13/did_america_need_a_jerk_instead_of_ben_bernanke_.html
dajeeps said:
Thanks. This is good stuff, but it’s more like a dramatic play by play of how Bernanke decided to control price fluctuations with an employment gap, made it very large and left it that way for years. And if he had it to do all over again…? I am still waiting to hear what he’d do differently.
dajeeps said:
Point conceded. But there is a doubt in my mind that Friedman would have advocated sopping up generally available liquidity and transferring it to the banking system because that just shifts the financial black hole from one area of the economy to another. Really, the entire purpose of having an elastic currency is to be able to handle that sort of problem without simply filling in one hole by digging another (while the hole their trying to fill just keeps getting deeper the more they dig out of the other). If I were to guess, this very thing is the reason the recession spread like wildfire in 2008. All of the losses from the financial system were being foisted on the broader economy and then some as the demand for liquidity soared. It’s true I don’t have a PhD, and haven’t been in academics my entire life, but it doesn’t take one to understand that at least Bernanke should have known better than to do this.