I’ve reached a milestone on my blog with 500 posts; the good, the bad, and the birdcage liner total now over 500 as I’ve created a few more than that since hitting that arbitrary 500 mark last weekend. To mark the occasion, I’m bring back some posts from some high traffic months on my site that I think are pretty good.
Today’s featured blast from the past is from December 3, 2012. Marcus Nunes had sent me a paper by Tobin titled Living with Inflation that contained a ghastly paragraph insisting that the central bank was not to blame for high and volatile inflation, and even if it were there was no better way yet devised to conduct monetary policy and we’d have to live with it.
The motivation for the post besides bad macro includes periods of history where the central bank appears to have become uncontrollable and unaccountable, with Tobin’s learning to live with inflation paper as exhibit A of unelected bureaucrats glibly foisting their intentions or hubris on the rest of us without warning, sans public debate, while being blind to their own failures. I mean one would think that central bankers should have to go through the political process to uproot the monetary framework and replace it with another if it means spiking unemployment and financial instability for years is what it takes to do it. Not so, at least in practice, leaving the nation’s economic health to the whims of bureaucrats in ivory towers.
It’s probably true that it’s much easier to get things done with a mind that asking forgiveness is sometimes easier than getting permission. But the ask for forgiveness part and remedies for mistakes come late if at all; such as the case of Bernanke’s and Mishkin’s foray into explicit headline inflation targeting that began almost as soon as both were sworn in in 2006.
Some of the quotes from the post are from Mishkin’s 2007 speech discussing the new framework (2% explicit headline inflation target was policy when the crisis came about, it just was not officially communicated until 2012):
The modern science of monetary policy proceeds under the assumption that the central bank’s purpose is to maximize the well-being of households in the economy…. Those components of the objective function capture the essence of the Federal Reserve’s dual mandate to promote price stability and maximum employment, a mandate established by the Congress for the ultimate good of the public.
The intertemporal nature of these objectives is crucial, as the well-being of households depends not only on their consumption and leisure at the present moment but also on their expectations about how that standard of living will evolve over time. Thus, policies that are intended to maximize the well-being of households must reflect both the present state of the economy and its expected path in future periods.
As I discussed in a recent speech, both inflation measures are important: Core inflation is a useful indicator of the underlying near-term trend of inflation, and overall inflation is what households and businesses ultimately care about (Mishkin, 2007c). Therefore, a significant aspect of the enhanced communication strategy is that the FOMC has added the overall inflation rate to its announced projections.
Every time I read this I wish I could go back in time and beg them not to do it. But as I am fully aware, that genie had already been let out of the bottle, with Mishkin to bail a year later in August 2008.
Anyway, the word intertemporal I think is an important cue that excess was of concern. But I wonder what market distortions from the supply side have to do with monetary policy. Looking at the state of the housing market at the time, there were plenty of indulgences there as the result of heavily subsidized mortgage lending. We’ve had a mortgage tax deduction for decades. We’ve had Fannie Mae since the 1930’s. Recent changes to both Fannie and Freddie, adding the clearinghouses and securitization schemes with lax fraud enforcement, and weakening of reserve requirements regarding securities purchased from the GSE’s had added to those prior subsidies exponentially against a backdrop of restrictive zoning in the areas that were hardest hit once the house of cards of subsidies came crashing down.
These were indeed problems. But the government narrative of the crisis has always been much different – that people can’t govern the use their own resources and are irresponsible, and these inevitably lead to destitution. Here, the central banker is telling his audience that the past is just as important as the present and future.
I am certainly not short of judgments, rightly or wrongly, and I certainly question why that kind of problem, a supply side problem, was being addressed by the central bank. The political system (elected folks) didn’t want to do anything about Fannie and Freddie, at least until the summer of 2007, and the last of the rate hikes didn’t end there.
There is nobody capable of convincing me that Mishkin couldn’t discern supply side problems like oil price socks from monetary problems, or that he didn’t understand the almost assured result of the policy being discussed – the AS/AD model is in his own textbook. Hubris is the only word I can think of which might describe this phenomenon of doing violence to the mandates for self-interested endeavors that may include schooling elected officials.
Even after the monetary mess of the 1970s with central bankers denying responsibility, thus claiming to be incapable of remedying the situation, the political system appears satisfied to be bent over a barrel by central bankers, with being blamed for hubris and/or incompetence of monetary authorities, and with allowing the kind of turmoil king-making created in medieval England to be inflicted on average people in an economic sense. It’s true that people aren’t killed in this kind of battle, at least directly. But in the case of bubble popping and targeting headline inflation, they are the economic equivalent of being pillaged and razed without the trouble of having an army do it.
None of this has been addressed, either internally at the Fed or on the floor of Congress, which seems to me to be an acquiescence that an extra-constitutional monetary authority can engage in this kind of behavior either intentionally or not. It could happen again tomorrow – which by the way, in my last post, I showed the possibility that the TIPS market is betting on a counterproductive hike of the FF rate – supposedly to prevent bubbles or some such nonsense because it cannot be justified by any material economic data.
(Graph below is from Marcus Nunes)