More than one tool for the Fed

One theme that emerged from the monetary policy conference at the Federal Reserve Bank of Boston on Friday and Saturday is that, as I stressed in my discussion of the recent FOMC minutes, the Fed is not thinking of large-scale asset purchases as the only tool available in the current environment.

Federal Reserve Bank of Chicago President Charles Evans made this quite explicit in his remarks at the conference:

If the Federal Reserve decided to increase the degree of policy accommodation today, two avenues could be: 1) additional large-scale asset purchases, and 2) a communication that policy rates will remain at zero for longer than “an extended period.” A third and complementary policy tool would be to announce that, given the current liquidity trap conditions, monetary policy would seek to target a path for the price level.

Many Fed-watchers understandably focus primarily on the first item since it seems more tangible. But as Evans noted, a prescription for pursuing the third strategy “regularly comes out of careful analyses of mainstream economic models that we use to assess monetary policy options”.

Federal Reserve Chair Ben Bernanke’s comments at the conference also framed large-scale asset purchases as just one element of a broader policy plan. He noted that inflation can be too low as well as too high, and gave the most concrete guidance to date as to exactly how low is too low:

Since the fall of 2007, the Federal Reserve has been publishing the “Summary of Economic Projections” (SEP) four times a year in conjunction with the FOMC minutes. The SEP provides summary statistics and an accompanying narrative regarding the projections of FOMC participants– that is, the Board members and the Reserve Bank presidents–for the growth rate of real gross domestic product (GDP), the unemployment rate, core inflation, and headline inflation over the next several calendar years. Since early 2009, the SEP has also included information about FOMC participants’ longer-run projections for the rates of economic growth, unemployment, and inflation to which the economy is expected to converge over time, in the absence of further shocks and under appropriate monetary policy. Because appropriate monetary policy, by definition, is aimed at achieving the Federal Reserve’s objectives in the longer run, FOMC participants’ longer-run projections for economic growth, unemployment, and inflation may be interpreted, respectively, as estimates of the economy’s longer-run potential growth rate, the longer-run sustainable rate of unemployment, and the mandate-consistent rate of inflation.

In other words, Bernanke is urging us to interpret the SEP longer-run inflation projection as the Fed’s de facto inflation target. And Bernanke also spelled out exactly what this means for anyone who might be slow on the uptake:

The longer-run inflation projections in the SEP indicate that FOMC participants generally judge the mandate-consistent inflation rate to be about 2 percent or a bit below. In contrast, as I noted earlier, recent readings on underlying inflation have been approximately 1 percent. Thus, in effect, inflation is running at rates that are too low relative to the levels that the Committee judges to be most consistent with the Federal Reserve’s dual mandate in the longer run.

We are thus in the historically unprecedented position that for purposes of both its employment and its inflation objectives, the Fed would like to be more accommodative. But what can it do, with short-term interest rates already essentially as low as they can go? Bernanke, like Evans, stressed Fed communication strategies as an alternative or supplement to large-scale asset purchases, though Bernanke noted that either tactic calls for a more comprehensive framework in place for designing and communicating exactly what the Fed is going to do.

Evans went much farther than Bernanke in proposing details of what such a framework could look like. Evans’ suggestion is to propose a path for the overall price level that would grow at 2% per year, as shown in the solid blue line in the figure below. If a 1% inflation rate for 2010 puts us below that desired path (as indicated by the black box on the graph), the plan would be to aim for a little higher than 2% inflation for 2011 and 2012 (red bars and dashed lines) in order to get back to the target price path.

Source: Evans (2010)

A key aspect of this plan is to

clearly state the terms for the final, state-contingent exit from the P* policy. Determining that the price-level path has been achieved with confidence is a critical determination. Presumably, spending a few months at the price-level path would be more important than simply the first achievement of the path. Once the price-level path is achieved with confidence, the forward-looking monetary policy strategy would return to focusing on 2 percent inflation over the medium term. Future policy misses on either side of 2 percent would be “bygones.” Policy would continue to strive for price stability over the medium term, which would be 2 percent PCE inflation. The past inflation misses would be used to simply inform current analyses of inflation pressures and improve future projections and policy responses.

Although communicating from the beginning what the exit strategy from the price targeting is supposed to be in specific quantitative terms might seem attractive, I worry it could run into a similar embarrassment as the infamous graph of the projected consequences of the economic stimulus package. Even in the best of times, the inflation rate will differ substantially from forecasts and policy objectives. And when the inevitable miss comes, one could imagine that the public would be less rather than more assured as a result of the Fed’s specificity in communication.

My guess is that, although the Fed may be thinking along the lines of a plan like Evans’, the communication will use the kind of language and flexibility displayed in Bernanke’s remarks.

At the Boston conference I also presented my paper with Cynthia Wu on the effects of large-scale asset purchases. Another possible framework for implementing such purchases came up in the discussion of our paper by Larry Meyer (former Fed governor and current managing director of Macroeconomic Advisers) and Joe Gagnon (former Fed officer and current senior fellow at the Peterson Institute for International Economics). They both suggested the possibility of targeting a longer-term yield directly, committing to whatever level of LSAP may be necessary to achieve that target. This has some obvious advantages over simply throwing some number of dollars at the market to see what happens. However, it is much trickier to negotiate subsequent changes in the target than is the case with a target for the overnight interest rate. Even when the Fed was targeting the overnight rate, it would sometimes find it impossible to prevent the effective fed funds rate from rising prior to an anticipated increase in the target as banks would try to arbitrage by buying more funds when they were cheaper. The fact that this arbitrage was essentially confined to the two-week reserve maintenance period for which banks were required to hold reserves was the key feature that made targeting the overnight rate manageable as a practical undertaking. Trying to do the same thing with a much longer interest rate is inherently a good deal trickier.

Another strategy would be to use a targeted rate on an intermediate-term security as a more precise way of codifying the “extended period” language. For example, if the Fed really intends to keep the fed funds rate below 25 basis points for the next three years, it could target a 0.25% yield on the 3-year Treasury bond, maintaining the target going forward in the form of a 0.25% target for the 2-year rate one year from today.

A related complication is the fact that the market has already anticipated substantial additional LSAP. My guess is that an additional trillion dollars in purchases is already priced into current bond yields and exchange rates.

For all these reasons, the key message of the November FOMC statement may not be the size of purchases that the Fed announces, but instead the framework it offers as guidance for exactly what such purchases are intended to accomplish.

52 thoughts on “More than one tool for the Fed

  1. Rob

    I understand from your previous excellent articles the danger of deflation but is inflation “good?” Is it that it lets people & governments with debt to softly default? How is 2% inflation consistent with a mandate of price stability when at that rate the purchasing power of a dollar is cut in half in a generation or so? (or 20% or so over nine years if I read the above graphic correctly 2005 = 100).
    I imagine that the twin mandate to the Fed, i.e. price stability and employment are there to balance the needs of workers and retirees but is this twin mandate incompatible? Would just price stability be more of a reasonable mandate for a non-politically-accountable agency?

  2. tj

    If other economies with inflation below target adopt the same policy then it seems like a defacto round of devaluations are on the way.
    It seems that a likely domestic impact will be import price inflation and commodity price inflation at rates that exceed wage inflation.
    The FED is going to kill the middle/lower class if they are not careful.
    Income, savings, home equity, and pensions will not keep pace with commodity and import price inflation.

  3. Richard A.

    The Fed should target nominal GDP and not the price level. Given that long term real GDP growth rate is about 3% per year, a GDPn growth path of 5% per year would give a 2% rate of inflation over the longer run.
    GDPn = P x GDPr
    Both GDPn and GDPr change faster than P. GDPr could falter but not show up immediately in P. You don’t have that problem targeting GDPn.

  4. Bob_in_MA

    What if Evan’s approach is taken and CPI rose in 2010 & 2012 as per his example, but this was led by commodity prices, and wages rise at a more moderate pace. In other words, you achieve higher headline inflation, but real wages are negative.
    Haven’t you just created a de facto tax on households?
    It might do a lot for the price of gold, but I don’t see how you’ve helped debt/income problem.

  5. Cedric Regula

    I think it’s time to require Fed members to go look for a job, starting with Evans. Maybe they will learn something about how industry works.
    But in the mean time Lord Blankfein and friends will be slobbering over what they will do with all the money the Fed gives them.
    Also, has anyone considered that maybe the Fed isn’t as stupid as they sound, and their sophisticated computer models running on an IBM Model 900000000, along with private input data from their banking buddies (including the PBoC), have determined that the USG won’t be able to borrow a trillion and a half next year, foreclosure gate is just the tip of the iceberg and will result in an implosion of MBS next year (and associated bank balance sheets), and QE2 is just a front to prepare for another round of TARP 2.0 bailouts and direct Fed purchases of impaired MBS?

  6. don

    I think we are in for an extended period (a number of years) of deflationary pressures. I don’t think targetting will work. If the Fed targets the long trm rate, what is the conceptual difference between the effect of announced price targets and that of the commensurate QE?Do they think they an get the desired effect with smaller purchases?

  7. JDH

    Rob: The worry is that if we wait until we’re in Japan’s situation to act, it may be too late. Specifically, if we stay here long enough, the 10-year yield would fall to zero on its own.

    Richard A.: Nominal GDP is an even harder target to hit. But it’s worth considering in this same discussion, in part because the inflation idea seems such a hard sell.

    don: The advantages of a target are that the Fed and market both know exactly what they’re getting.

  8. Joseph

    I am stunned that the Fed position on targeted inflation seems to be “We might fail. Therefore we must not try.”
    Millions of peoples lives are being destroyed and the Fed’s primary concern is that they might embarrass themselves. We need a Fed with more courage and less cowardice. But, of course, they are not members of the suffering class so their position is understandable. As long as bankers run the economy, nothing will change.

  9. David Pearson

    Your chart shows the inflation rate falling in 2013 — presumably as the Fed tightens.
    What if unemployment is 8.5% in 2012, the peak year for inflation? The Fed would arguably not tighten in the face of high unemployment. That means the inflation target is asymmetrical except in the case that an inflation target ignites robust, sustained, real growth. I’d be interested in hearing the “Plan B”: what the Fed should do if the price level target is reached without much real growth in the interim. So far I have heard the following “Plan B’s”:
    -“of course we’ll have sustained real growth, so why worry about it?”
    -“the models tell us high inflation is incompatible with a large output gap: a ‘Plan B’ is unnecessary.”
    -“the Fed is independent, so ‘Plan B’ is to tap on the brakes as we reach the level target, even at a cost of rising unemployment.”

  10. JDH

    David Pearson: Here was how Charles Evans answered that question:

    The second challenge is to imagine that the degree of resource slack in the economy is much smaller than many presume. One example would be if the structural rate of unemployment was upward of 8 percent. In this case, more accommodation could lead to higher inflation and a rapid closing of the price gap.

    As it turns out, this is not a challenge for the P* policy: A quicker closing of the price gap harkens the exit of the state-contingent price-level policy. The fact that unemployment would remain high would be a signal that increasing aggregate demand alone is not enough to address this problem. But monetary policy would have succeeded in moving closer to price stability with the attending benefits from achieving that policy goal. Confidently switching to the post-P* policy would enhance credibility for price stability over the medium term. And we would have done all that we could to address the employment situation—which would also enhance Fed credibility, in my judgment.

  11. andi

    it is all going to blow up by 2012 anyway…
    good luck experimenting…
    OIL is shooting ahead to $125 near term and $150-200 in a blow off..Gold to$3000 in 2 yrs..
    Welcome to new weimer republic…

  12. JDH

    Joseph: By “embarrassing” I mean “lose credibility.” The Fed’s credibility is the single most important asset it has for purposes of being able to help the unemployed or anybody else.

    Your broader point that the risks of the policy backfiring need to be weighed against the known enormous costs of doing nothing is well taken, and is exactly the point that I emphasized here.

  13. The Rage

    TJ: Why do you bother to post? How is the “FED” going to destroy the middle class ANYMORE THAN IT SHOULD BE DESTROYED RIGHT NOW sans the pretend schemes of the FED. Either you understand the nature of debt deflation or you do not
    andi: Why make a post about “oil” and “weimer” WHEN THAT CANNOT HAPPEN IN DEBT DEFLATION! EVERYTHING IS INSOLVENT! The FED only prints toward the financial community which cannot talk the “printing”. Hence, everything printed to them dies and never hits the money supply. It is why it is called “pretend and extend” so the banks assets are not called in ala Lehman.
    Both represent the ignorance and stupidity of modern day blogging. Ignorant subsets of individuals who are weak minded and need easy answers to create a outcome based on intellectual fantasy. Why the plutocracy uses them to continue its nation destroying activities and pillaging. Then we have the mouthpieces of plutocracy who use the tj’s and andi’s as cattle slaves.

  14. tj

    Is it possible that too much wealth has been destroyed in the form of home equity, savings and pensions, for monetary and fiscal policy to sufficiently stimulate AD?
    Perhaps we have borrowed ourselves into a situation in which there is no way around a stagnant decade with periodic episodes of deflation regardless of QE2 or no QE2. Is that possible?
    Personally, all that QE2 will do for me is to keep the return on my savings ~0% and increase the price of energy and other import prices for things like clothing. It won’t do much for my salary. I don’t see it helping my pension much either. I reallocated much of my bonds and equity into less risky assets, because I didn’t anticipate the FED artifically propping up the financial markets.
    I don’t think deflation caused by too little AD chasing too many goods is a monetary phenomenon, and I am skeptical of a monetary solution.

  15. Anonymous

    JDH: By “embarrassing” I mean “lose credibility.”
    I understand that, but how much credibility does the Fed have now? Normally the Fed is trapped between two conflicting goals of higher employment and higher inflation. Yet now when they are significantly below both targets and there is no conflict, they mysteriously are paralyzed into inaction. It takes a peculiarly incompetent Fed to undershoot both goals and dither about which direction to go next.
    The only explanation is that they see no need for urgency. Unlike the recessions of the 80s when everyone, including business leaders, felt the emergency, this recession is class based. White collar college graduates have an unemployment rate of about 5% and the bankers are doing just dandy, but for everyone else the unemployment rate is 15% to 20%. The Fed and the bankers who run it simply don’t see it as an emergency because they and their friends are doing just fine.

  16. David Pearson

    In the quote, Evans skirts the issue. He assumes inflation targeting allows the price level to reach “stability” and magically come to a stop. In reality, the Fed would have to tighten to arrest a price level that is overshooting the target. This tightening would come at a time when unemployment — structural or otherwise — is already unacceptably high. At that point, how many economists would accuse the Fed of “risking another Great Depression” if it pursued policy symmetry?

  17. jzw

    What does inflation targetting mean for the long term holders of US Bonds ie those that had planned to hold those bonds to maturity (not the speculators that only want to hold until they can sell them to the Fed). Is this an attempt by the Fed to destroy pension funds and the retirement hopes of a generation? What will happen to Japan as the largest foreign holder of that debt? Will middle-east countries continue to exchange valuable oil for worthless paper?
    The Fed need to get out of their ivory tower more.

  18. marc fleury

    Annoying all the anonymous comments. Cant’ people speak about monetary policy, even the extremists without hiding behind their little finger.
    To me the situation is straightforward, we are exiting a massive debt fueled bubble on real estate. Prices are so high that many of the younger generation cannot afford living. We have had massive INFLATION of assets, financial assets. And so the housing market wants and needs DEFLATION.
    QE1 was aimed at stopping the negative spiral of debt deflation. It was aimed at the dynamics of debt deflation. The “fisher capsizing” moment was to be avoided, where the rate of debt reducing engenders a faster rate of asset deflation. FINE, the goal of “stability” defined as a “deleverage in equilibrium” was fine by me.
    QE2 is a very different beast, we are arguably in relative stability, the markets have volatility but no fisher moment. WE are in “semi-equilibrium”. From any point the prices can go up or down without dramatic impact. AND THE HOUSING MARKET WANTS TO GO DOWN, HAS TO GO DOWN. And now we are talking about PRICE STABILITY. This is where I disconnect and go on a rant.
    QE2 is theft, by those who have on those who don’t have. Be it the middle class or the younger generations, those who have enjoyed the inflation years and want to keep their false gain, the price of their house is their ATM and pension rolled into one. The FED is quick to help the banks with their assets.
    The more I study the money system, the more I like my dog.

  19. foosion

    JDH: By “embarrassing” I mean “lose credibility.”
    The Fed is required by law to try to achieve full employment and price stability, goals which it acknowledged in the most recent FOMC statement. Is it less embarrassing to ignore its legal mandates?

  20. Johannes

    Hi guys,
    —– Tuesday, Oct 19th —–,
    8:00 AM: Goldman Sachs earnings will be announced.
    As my ex-buddies told me just now : higher than expected !
    That is to say, TARP worked well, QE1 worked well, QE2 will work well, Cheers.

  21. RebelEconomist

    “as Evans noted, a prescription for pursuing the third strategy “regularly comes out of careful analyses of mainstream economic models that we use to assess monetary policy options”.”
    That is the problem. Mainstream economic models do not seem to allow for policy moral hazard. I suspect that this (ie the Greenspan put) made a major contribution to the financial crisis, but it does not yet seem to have been built in to economic models (if it could be). If the Fed shows willingness to relax its inflation objective when it restrains them from easing as much as they or the public might like, then markets will assume that it will happen again, which of course will make it more costly to stand fast when the test comes, and so on.
    Also, I note that there is a sleight of hand between the long run SEP forecast of inflation and the claim that inflation is below that target, which is based on inflation ex food and energy. Given that the rise of Asia etc seems set to generate a secular relative rise in commodity prices, hitting the target for headline inflation will probably require the Fed to keep core inflation somewhat below the headline target most of the time. Again, markets can see through these tricks.

  22. Ricardo

    I seem to detect the stench of possible wage and price controls. I understand that when a FED governor suggests “…monetary policy would seek to target a path for the price level” his thoughts are on targeting the general price level but that tells us nothing more than what we already know. The question is what actions they will take to determine them achieve their general price level target. It is just a short step for congress to take to “help” the FED with a little wage and price control. Boy, would that not be great? And for those who wish to blame Democrats let me remind you who last instituted wage and price controls, good ol’ “Tricky” Dick Nixon.

  23. FX

    Hmm, this piece seems to be somewhat misleading – as much as there are “more than one tool for the Fed”, it’s more correct to say there is only one more target left (the only 2 tools* already in used, “extended” has been mention so many times people stopped caring, and QE(asset purchase) has never stopped since 2008). Whether this be price targeting, nominal GDP targeting, by necessity it depends on the two tools. Unless economy picks up, or Fed aggressively prints (POMO, etc), just jaw-boning a price target won’t work.
    *personally make a distinction between what a tool is, what a target is: a tool is something that can be explicitly managed at will. i.e, print trillions of usd/create credit, pricing/charging at fed fund rate. A target is a best case scenerio, implictly depends on something else, and what you may do might be off the mark.

  24. kharris

    The trick for households is whether wages rise fast enough to reduce the real debt burden, taking into account the cost of living. Wage gains below the pace of price gains makes that harder, but not impossible. Fast wage gains and fast price gains (not what the Fed is looking for) make the trick easier to do that if wage and price inflation is slow.

  25. Chinaboy

    One more tool that the Fed has but not mentioned in the article is that economic theory is a printed voodoo.

  26. David Pearson

    I believe the whole point of the exercise is to reduce real wages. The idea is that unemployment is caused by sticky nominal wages, so creating inflation reduces real wages and allows the labor market to clear. So, according to the models, higher food and energy prices are a good thing…

  27. oc

    “The Fed’s credibility is the single most important asset it has for purposes of being able to help the unemployed or anybody else.”
    JDH, I wonder about this point sometime. Price-level targeting would require a period of above-target inflation at some point in the future. Given that this would likely occur during recovery, it’s hard to believe, given the Fed’s inflation credibility, that it would actually let this happen. I.e., PLT seems time-inconsistent for a credible “hawkish” central bank. Switching to such a policy during a crisis also smacks of discretionary policy, which would further lead me to believe that, once the recovery is under way, the Fed would revert back to inflation targeting rather than allowing the ex-post higher inflation necessitated by PLT.
    More broadly, if one of the ways in which the central bank could currently help is by raising inflation expectations, thereby lowering real rates, the credibility of the Fed works against this. Who thinks that the Fed would deliberately allow sustained inflation, even at historically low levels like 3-4% for any extended period of time? In this sense, perhaps credibility has a downside, when credibility is interpreted only in the inflation-hawk sense. A less-credible central bank might find it easier to raise people’s expectations of inflation than our modern central banks who have spent the last 30 years wringing inflation out of the system.

  28. Wisdom Seeker

    Another tool: the rate of interest on excess reserves. What would happen if the Fed started to charge interest for excess reserves, rather than paying interest?

  29. Steven Kopits

    We had Meet-and-Greet week at Douglas-Westwood last week, which involved visiting some of the big investment banks and leading private equity funds. Here’s the take-away:
    – credit markets are open and increasingly competitive
    – investors are seeking yield and eschewing equities for junk bonds and yield vehicles likes MLPs
    – private equity funds are finding valuations pretty high in the oil field services sector
    – GE’s acquisition of Dresser raised some eyebrows. “GE has $30 bn in cash and needs to spend it. Anything is more accretive (raises earnings more) than cash.” So GE spent $3 bn on Dresser, a mature company, at a valuation of 10x EBITDA or 1.5x revenue–a pretty high value. This suggests that the corporates are seeing pressure to deploy their cash hoards, in part in acquisitions.
    I don’t know if I would draw too much in the way of conclusions from our visits, but the message was consistent and would seem to suggest a lot of cash pushing asset valuations in 2011.

  30. don

    “My guess is that, although the Fed may be thinking along the lines of a plan like Evans’, the communication will use the kind of language and flexibility displayed in Bernanke’s remarks.”
    “The advantages of a target are that the Fed and market both know exactly what they’re getting.”
    Do you sense, perhaps, a small contradiction here? How mcuh faith in the targetted inflation would such ‘flexibility’ provide?
    Even if the Fed can succeed in promoting inflation, I doubt it can get the type of inflation it wants. If we get higher food and oil prices, but not wages, then this will not help reduce debt loads. And how will targetting bring even this about? True, if people really believe the Fed, then real interest rates can be depressed, so they will be discouraged from saving and encouraged to invest. But I think these effects are likely to be quite small – both saving and investment are much more importantly influenced by income levels than by the interest rate. So the natural downward pressure on prices from excess capacity and unemployment would dominate. Only the exchange rate effect seems possible – we try to beggar our neighbors. This is not likely to end well, especially if the Asian pegs continue, so whoever is bearing the brunt of our exchange rate policy must support the entire ‘Chimerican’ economy on their shoulders.

  31. flow5

    Required reserves have expanded by 29.7 per cent in the last 13 weeks.
    Excess reserves have declined by 26 per cent in the last 13 weeks. Excess reserves have declined by $228,652b from their Feb. 24th peak.
    These are all positive developments.
    The problem is that there is already a capital cushion for the member banks. It is called Basel II. This capital cushion is not regulated as excess reserve balances.
    The BOG’s remuneration rate @ .25% on excess reserves (IBDDs), exceeds the “Daily Treasury Yield Curve” – past 1 full year.
    Lowering the remuneration rate on excess reserves should be the “tool”. Let the free markets determine interest rates. And let the free markets allocate credit.
    Force the commercial banks to expand their earning assets. And leave the Reserve bank politics, & the FED’s balance sheet, & FED credit, alone (as much as possible).
    The member banks aren’t reserve constrained in the first place (the housing bubble was a good example). IORs have just been a dis-incentive to lend & invest (contractionary) & used to offset the FED’s lending & liquidity programs (& expanded balance sheet). IORs are no longer needed.

  32. 2slugbaits

    JDH: Is the primary goal here to use inflation to stimulate consumer demand by reducing existing debt burdens (i.e., repairing balance sheets of private debtors), or is it to try and lower the cost of longer term investment by raising the opportunity cost of stuffing cash into mattresses?
    Also, a number of commenters have argued for including the cost of energy in the Fed’s inflation target. Aside from the fact that including energy would not give us “core” or inertial inflation, it seems to me that there is another often overlooked problem with including energy prices. Energy prices are largely driven by the price of oil imports, which means oil imports are not (by definition) part of gross domestic production. So why would the Fed want to include imports? In other words, the Fed’s concern ought to be the extent to which domestic production is up against a NAIRU limit. It’s entirely possible that overall CPI could start to increase even though the GDP Deflator points towards continued disinflation? Wouldn’t it be more appropriate for the Fed to concentrate on the direction of the GDP Deflator, setting aside the fact that the Deflator is only quarterly?

  33. Nemesis

    Did you mean the title to read “More than one fool for the Fed”?
    If we think the Fed is anything more than a money-printing bad asset swapper for the insolvent banks to shore up their “unbalanced sheets”, then we’re the fools, and the Fedsters are doing their job well.

  34. Niraj Kumar

    ….But why do we forget that the premise presented in the article rests on the assumption that there will be stability in the international market with Chinese Yuan more market driven……moreover we cannot get the holy grail of trinity in the macro economical condition that is favorable exchange rate, controlled inflation and good GDP growth (growth in employment)….it is basically like squaring a circle and I know at least by all these summary projection (abracadbra) at least Fed Chief will articulate that he has done the impossible…..

  35. ppcm

    Marc Fleury
    “Annoying all the anonymous comments. Cant’ people speak about monetary policy, even the extremists without hiding behind their little finger.”
    Throughout these past years I found that monetary policies,money matters are not an intellectual theorization only.
    It is much easier to be established political,financial crooks or genuinely cretins be they,political, banker(s),economists, freelance tabloids financial writers, and survive.Having for sole accomplishment to have profited, driven,commented, caressed and insulted population,representatives of their success in the demised economies.
    There is no rush
    “Young people, have always had to make the revolutions than their decaying fathers prepared for them”

  36. Cedric Regula

    I could answer your question, but I’m quite sure you will tell me that I don’t understand macroeconomics, so I won’t bother.
    But aside from the issue that the Fed doesn’t know what inflation is, so by corollary wouldn’t know what price levels to target, or even if they would be asset prices all of a sudden, here’s what some real economists have to say about QE.
    It’s not good. Stiglitz, Hussman and even MMT guru Wray speak out against.

  37. tj

    Thanks for the link Cedric. Stiglitz has it right in terms of the way he has framed the issue. There is no obvious binding constraint that QE2 will relax. There is a surplus of excess reserves in the banking system so a further infusion by the FED will no nothing to move excess reserves into loans.
    He didn’t directly address the deflation issue. But, if the cash from QE2 doesn’t increase lending, then there is no impact on M and no sustained general increase in prices.
    Thus, we are left with the major impact of QE2 being a devaluation of the dollar, with rising commoditiy and import prices. i.e. Food, Clothing and Energy price inflation but no wage inflation.
    It sounds like a prescription for a drop in real income while HH’s are trying to save to restore the wealth they lost from the decline in home equity and the decline in retirement account balances.

  38. ppcm

    The further downwards interest rates are depressed (QE+n),the further profits in the banking system.
    Interest swaps can be unwound at profits why ? Interest yield for the last 10 years is one way road down and further down.
    Interest swaps have two components:
    Interest rates differentials $ vs other currencies.
    Foreign exchanges with other currencies,see the unconventional behaviour throughout these last 10 years (most likely a stronghold of long dollars in the permafrost) Unwinding the forex leg may drive a dollar depreciation.
    Clearing, off balance sheet of the incriminated banks,leading towards a better reading of the contingent liabilities.
    Not of the assets waiting for a real stress test (see previous Econbrowser post)
    Lower mortgage rates
    The whole gas plant is not only made in the US of A of course!
    Please see the OCC report on derivatives

  39. Cedric Regula

    Ya. So the Fed prints until DOW 15000? Median US home price $250,000?
    Do we trim outlier NE and CA home prices when going to US Home $250,000?
    What if they target US health producer prices and their model demands a 20% Fed funds rate?
    What if the dollar drops 50% to increase exports and the only thing that happens is Wintel profitability explodes?
    What if oil goes to $200, and that doesn’t make us feel rich?
    What if the Eurozone brands the US a currency manipulator and slaps on a 50% import duty?
    So many questions to answer.

  40. 2slugbaits

    I don’t know of anybody who is thrilled at the prospect of QE2, but you have to compare it to the available options. We have stupid politicians because we have stupid voters, so fiscal policy is off the table even though that should be the preferred option. So now we’re left with some Hail Mary passes from the Fed. It sucks, but at the end of the day we get the kind of politicians that we deserve…and it looks like after November we will get even more of what we deserve.

  41. Cedric Regula

    Yes, the Fed did use to have a saying “First, do no harm.” Even to I’m not a GReenspan fan either.
    And targeting fiscal policy would be preferable, except to qualify as immediate stimulus it would have to be something “shovel ready” (fill potholes…again) or tax breaks, again.
    Since the government is going very broke and the US has forgotten how to fund something worthwhile, like the Hoover Dam, I suspect that is the reason the voters have tied of that approach.
    Plus anyone that goes to the store doesn’t believe we Ree having deflation anyway. Plus deflation would be much more damaging to China than the US in today’s economy.
    They could declare China a currency manipulator and that would stop the long term bleeding of offshoring, but check with Tim on that.

  42. don

    “and it looks like after November we will get even more of what we deserve.”
    The American voter is a spoiled brat, but there’s nobody around big enough to spank him, so we have to let him suffer the consequences of getting his own way and hope he takes away the right lesson. It’s just too bad the innocent will have to share the consequences.

  43. 2slugbaits

    Cedric Funding a “worthwhile” project would be nice, but it shouldn’t be a deal breaker. The problem is weak aggregate demand, not inefficient spending. In any event, there are plenty of worthwhile projects. There’s a tunnel in New Jersey. There’s sprucing up the nation’s mall area in DC. There are thousands of unsafe bridges, including many along interstate highways. And keeping teachers on the payroll. How about supporting shortfalls to state budgets? And pretty soon a lot of midwestern states are going to be looking at snow removal. And the military could pull forward overhaul programs of equipment coming out of Iraq. Sorry, I just don’t buy the argument that fiscal spending would be too much bother so why try.

  44. John Smith

    Is there one single shred of evidence that having a federal Reserve interfering with the economy has ever had any benefit? Seems to me that all their actions do is cause distortions that lead to capital misallocations and bubbles. How nice if they simply didn’t exist and business could simply get on with it.

  45. aaron

    Give a small tax break to banks that enact an interest moratorium on bubble mortgages and make principal payment tax deductible for those mortgages. This would apply to people who make their full scheduled payments. Might be good to make the principal tax deduction extend to a little more than the scheduled payment amount.

  46. nilys


    Fiscal policy is not within the scope of the FED. As a long aside, it seems to me that to right the economy we need more than to fill a couple of pot holes. Without demand, tax cuts will be pocketed. I think it was Setser, when he still maintained his blog, who asked readers to suggest what policy should be followed to get out of the recession. My view then and now is we need direct grants to support novel projects and ideas. The mechanism could be something as the following: announce broad programs – novel projects in nanotechnology, biotechnology, green energy, urban sprawl and transportation, air pollution, rare earth metals, recycling, oil exploration, whatever the needs of the country are; put a committee of experts together and let them decide which proposals make sense; fund the best projects for 5-10 years; allow small businesses, start-ups, non-profits to apply; label this “rebuilding America”. This would have an immediate effect. Awardees will rent office, research and production space – here’s a solution to the glut of commercial office space. New graduates would get jobs. It would make sense again to get a college degree in subjects other than finance. Wages may go up as there will be competition for best talent to fill up the newly created positions. I don’t think that talent atrophied in the US, it’s that there seems to be a lack of willpower among the leadership.

    The FOMC can’t declare China a currency manipulator, it’s Tim’s job. I fully support stopping bleeding of manufacturing abroad. But let say, a revaluation happened, I have not seen a serious analysis of what it would lead to. This Chinese analyst Shaun Rain writes in Forbes that it would eat up profits of the US companies producing stuff in China and selling in the US. It would probably make life difficult for companies like GM, which make and sell stuff in China. At this very point, it would also likely increase unemployment, send more people into foreclosure and suppress living standards of everyone, not only those who shop at Walmart. Outsourcing has been going on for how long now; can it be reversed in a day by merely declaring China a currency manipulator? Furthermore, do we want back textile manufacturing? Hence, see above, we need investment in innovation to create new industries at the same time as we gradually render the dollar more competitive.

    As another aside, the electorate is what it is, it’s probably been this way since the times of Athens. Where are the community and business leaders? The leaders are supposed to lead.

  47. Cedric Regula

    There are a ton of things the USG could fund, it just takes long term planning. An energy independence program would be necessary from a rational standpoint.
    Our economy has adapted to cheap imports. There will be some pain to change that. But wiping out your currency to become a third world country has to be the worse way. They say if we don’t buy low cost consumer products from china, we will buy them from a different third world country. I think this may be good, because then there is some chance another country will have dollars to spend on US exports, and we may get balanced trade rather that just free trade. And creating jobs in Mexico sounds pretty good nowadays.
    Absolutely correct that everything is NOT the job of the Fed.
    As far as I can tell, our leaders spend their time buying votes with tax breaks and passing special interest legislation. Don’t know if that will ever change.

  48. Jeff

    Even in the best of times, the inflation rate will differ substantially from forecasts and policy objectives. And when the inevitable miss comes, one could imagine that the public would be less rather than more assured as a result of the Fed’s specificity in communication.

    You’re quite right. The right target is a path for the expected price level, not the price level itself. Expectations are what counts, and you can target them pretty accurately. The announcement of the target itself will get you part way there.

  49. don

    “Expectations are what counts, and you can target them pretty accurately.”
    This is a rather surprising statement, at least to me. Surely there must be some slips ‘twixt the cup and the lip, including trust in Fed statements (Would a new chairman be bound by what the old one said? Are you sure even the same Fed chair wouldn’t succumb to expediency of the moment? Would the Fed be willing to make the implied sacrifice in its ability for discretionary action?) And, of course, translating ‘Fedspeak’ is always problematic. Or do you think the Fed would abandon this mode of communication?

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