As Marcus Nunes pointed out in a recent post, one of his colleagues at Bloomberg, Michael McKee asked Janet Yellen at her post-FOMC meeting news conference a question I have been begging the media to ask for at least a year about the justification for beginning the tightening cycle this year (good show Michael!).
Janet Yellen, however, evaded answering the question by responding with a hypothetical, nothing resembling evidence, in a way that is misleading.
The following is the exchange from the transcript of the meeting in which I will dissect Yellen’s answer below:
Michael McKee from Bloomberg Radio on television. If the economy develops as the summary of economic projection suggests, you will see improvement in labor markets but it won’t push inflation up any faster. So I’m wondering what the argument is for raising rates this year as suggested by the dot plot, because even allowing for long and variable lags, you’re not forecasting an inflation problem that would seem to suggest the need for a steeper and faster rate path for at least a couple of years.
So, if we maintain a highly accommodative monetary policy for a very long time from here and the economy performs as we expect, namely it’s strong and the risk(sic) that are out there don’t materialize, my concern will be that we will have much more tightening in labor markets than you see in these projections and the lags will be probably slow, but eventually we will find ourselves with a substantial overshoot of our inflation objective and then we’ll be forced into a kind of stop-go policy. We will have pushed the economy so far it will have become overheated. And we will then have to tighten policy more abruptly than we like. And instead of having slow steady growth improvement in the labor market and continued improvement in good performance in the labor market, I don’t think it’s good policy to have to then slam on the brakes and risk a downturn in the economy.
Yellen blows the answer in the first part of the first sentence: “So, if we maintain a highly accommodative monetary policy for a very long time from here…”
So what IF the FOMC did maintain a highly accommodative stance from here? Asking the question in that way is misleading as to frame the situation that the FOMC is indeed maintaining a “highly accommodative” policy stance when that is not likely the case.
Having the FF rate set at 25 to 50 basis points says nothing about policy accommodation without the added context of the Wicksellian equilibrium rate, which she neglects to mention, and which is likely being reduced during the ensuing downward trend of market volatility. A policy rate set at 25-50 basis points is not now accommodative if the Wicksellian equilibrium rate was lesser or equal to the FF rate prior to market conditions changing. Under conditions that lower that rate, policy is becoming tight without anything at all having been done by policymakers – natural tightening. One could argue that the Wicksellian rate was approximately equal to the FF rate at the beginning of July and I might agree with it. In which case, policy would have been neither easy nor tight, certainly not “highly accommodative.”
Moving on to the second part of the first sentence: “…and the economy performs as we expect, namely it’s strong and the risk(sic) that are out there don’t materialize, my concern will be that we will have much more tightening in labor markets than you see in these projections and the lags will be probably slow…”
If nirvana continues… Do you really believe in unicorns? If the problems in China and elsewhere don’t hurt too much – except in lowering the Wicksellian equilibrium rate and tightening the policy stance which hurts everyone from the top down to single-mom waitresses, as if a little or a lot of pain only matters in degrees of severity.
And the reference to being concerned about much more tightening in labor markets is a kin to saying that too many people may become employed. Oh, the horror of such a development! In an era of historically low LFPR are people listening to this?
The second half of the sentence regarding lags is a real whopper as Yellen tries to have her cake and eat too. That policy lag is really something, sometimes faster, sometimes slower, nobody can ever be sure. So what does she have to say about policy choices of the recent past such as the taper and the end of QE3 verses currently sinking inflation and NGDP expectations? Zippo. If there is a lag, we’re certainly beginning to see a problem with the aforementioned policy choices. Ms. Yellen and her colleagues are either making the tight money policy mistake now or they made it last year – either way it is still bad policy!
Now for the third part of the first sentence: “…but eventually we will find ourselves with a substantial overshoot of our inflation objective and then we’ll be forced into a kind of stop-go policy.”
Keep in mind that this information is based on the hypothetical of providing an accommodative policy with no proof that policy is now accommodative, unless of course she is implying that her preference would be even tighter policy then we have today. Perhaps she did not intend to imply this as there is very little justification for another policy-induced disinflation. But when one is free to tighten the policy screws as one pleases without accountability for any ensuing disaster, playing fast and loose with semantics is apparently not of much concern.
What Yellen said here is that if easy policy were to actually happen and continue, there would EVENTAUALLY be a problem. I can’t necessarily disagree with that. But easy policy simply isn’t the case for at least in the longer part of the medium term and I don’t believe we should be now solving a problem that doesn’t exist if it can happen at some point many years into the future. Perhaps someone should ask her about the opportunity cost of conducting policy this way, though I think she has already spelled it out regarding her concern that too many people becoming employed and producing. (Isn’t that what keeps a lid on inflation? But what do I know?)
I believe the question posed to her was, if we don’t have a problem for at least a few years, why are you tightening now. Thus it’s helpful to define what a “problem” is. We’re already looking at 2018 having a headline PCE inflation rate of 1.8% according to the Fed’s own forecast, which has a track record of being overly optimistic. The Fed’s target is an average of 2% inflation on the PCE headline index over the medium term. Any other kind of interpretation would not be consistent with the Fed’s mandates. In lawful conduct of policy, at some point PCE inflation has to rise above 2% in order to average 2% in either the medium or long term. And the Fed’s statement says 2% is a medium term objective, giving it less time to average 2%. And so, the Fed’s own inflation forecasts say the even in 2018 it will not have met its objective.
In summary, I can’t disagree that we do indeed have a monetary policy problem in the present with clear risks to the future. But it is not of the variety assumed by Ms. Yellen in a sort of off the cuff, misleading and haphazard response to a valid inquiry for justification of her policy preferences. She wasn’t just talking to a reporter either. These are things she was communicating to the public, and I certainly hope they were listening, take note, and “do the needful” in order to prevent the monetary tragedy from continuing.
I had intended to dissect the entire Yellen response to the question in one post. But, for now, I have read, digested, and written more than my mental capacity for nonsense can endure. Perhaps I will have more forthcoming.