And now, here are my answers to the “Fed Questions.” There aren’t really right answers on most of these, but a Fed chair should understand the questions and the pro/con arguments.
1. Remove the full employment mandate from the Fed, whose tools to promote employment are weak and their use generally conflicts with price stability.
2. Yes 0% inflation is achievable but recognize that today’s policy execution takes 12-18 months to affect price levels.
3. Changing federal funds rate has zero impact on current inflation. Pick a number for real rate (adjusted for month to month inflation) and stick to that. Any other policy distorts credit markets unnecessarily.
4. Use FOMC trading to control money supply to stay in synch with GDP. Grow the money supply more slowly than GDP until inflation stabilizes at your goal number. Then allow money supply to grow exactly the same as GDP. Remember you are affecting next year’s inflation rate with this year’s actions. Don’t be afraid to constrict money supply when GDP falter!
The real risk I see is that the Fed is pressured to finance deficits so the politicians don’t have to raise taxes. Banana republic public finance, they say.
I would love to hear much more from Fed on how they incorporate fiscal policy into when setting rates.
Obviously they don’t like disclosing that they would offset the will of elected officials by raising rates when Congress stimulates the economy. Crucial aspect of the job and almost no direct discussion of how they react to stimulus. Clear in the income replacement programs during Covid, if you give ordinary or poor people money, they seem to spend it. You give rich people tax breaks, the save it ( ok maybe invest it ) and so not as stimulative. Ok maybe they spend some but fiscal multiplier much muddier when marginal propensity to consume < 1 for majority of $ involved. Fed clearly has a lot of fiscal responsibility given their authorities.
The management of the balance sheet needs to change. Not new, but Fed changes the net maturity structure of debt via QE. How is this allowed ?
Waller sounding out the Fed duration risk needs to be lower which I welcome. Even at ZLB the duration risk from a more timely recovery and rate normalization is high. Keep the Fed closer to a narrow bank. Agree it’s outrageous TNBs not allowed but Tether is just fine. Only $ stable coins showing large demand as crypto firms still go under banked and also $ stable coin demand subverts AML/KYC banking regs. $ stable coins dominate as most other currencies it’s already easy to launder money( just my opinion ).
PPP fraud and Zoom class excess savings exacerbated inflation. PPP and sibling programs may have both done the most good of a government program and also done the most bad because the $250 billion in fraud was like venture capital for criminal organizations and led to a spike in violent crime and fentanyl deaths. So we know from Clinton’s and Obama’s tax increases that wealthy don’t need tax cuts because the banking system serves them. So wealthy people have no problem getting lines of credit to expand businesses or buy a house and so tax cuts for the wealthy just increase generational wealth.
A defense attorney for the accused never asks a witness for the prosecution a question that he does not already know the answer to. Your list of questions is all over the map. There is no unifying theme, and the answers provided in the second (this) posting are likewise all over the map with no unifying theme.
How would you implement a price-level target monetary policy? Start with the definition of the rate of inflation: inflation = time rate of change of the logarithm of the price level,
i.e., π(t) = dp(t)/dt, where p(t) = logₑ(P(t)). Now, suppose that you, the central banker, have set monetary policy such that P(t) = P* for all time, t, with P*(t) the price level that you have defined as the price level of consumer prices for all urban households. How do you propose to achieve that price level target, P*? If P(t) > P*, π(t) must be negative to return P(t) to P*. Conversely, if P(t) < P*, π(t) must be positive to return P(t) to P*. Obviously, periods of negative π(t) are periods of deflation (not just disinflation), and periods of positive π(t) are periods of inflation. Clearly, no control system that acts with a finite time lag will result in a perfect record of price level stability. There will be drift, and there will be shocks that move P(t) about the target P*. How will you discern when to act? You can implement a monetary policy which allows for small differences, |P(t) - P*| ≤ ε∙P* , with 0<ε≪1, without requiring a monetary policy response, but when the differences |P(t) - P*| > ε∙P*, a monetary policy response to return the price level, P(t), to target P*± ε∙P* is implemented. Now, there are two policy decisions: (1) what is the appropriate positive value of ε, and, (2) what is the appropriate policy response when a monetary policy change is called for? We know how to respond when P(t) < P*- ε∙P* -- we lower the overnight reverse-repo rate for as long as it takes to generate the level of inflation, π(t), that brings P(t) to within the range P*± ε∙P*. That part is standard operating policy. How should monetary policy respond when P(t) > P*+ ε∙P*? It is not enough to bring inflation to zero, π(t) = 0, because the price level targeting policy states that |P(t) - P*|≤ ε∙P* , with 0<ε≪1, is the target price level range. Deflation must be the answer in the case of P(t) > P*+ ε∙P*. How to achieve that? Deflation is not disinflation. It is a severe and prolonged economic recession. How palatible would that be to Congress and/or the Administration in Washington, DC? I'm sure that you get picture. The response would be visceral. "It ain't gonna happen, son." And, there endth "price level targeting" as monetary policy acceptable to the powers that be.
I think that your observations point toward cautious but serious and clearly beneficial reforms. We may be past the point where a conservative approach to reform would be sufficient, yet trying less-disruptive options first would surely improve the situation. The Fed's institutional assumptions are doing enormous damage, especially the acceptance of perpetual 2 percent inflation. That has to stop.
It's funny how people complain about Trump taking power but ignore the Fed. Why should the Fed allow any inflation? Who said they could do that? Who told them to monetize the debt issued by reckless fiscal policy during Covid? Why not let the markets set the interest rates? The Fed has a lot of unchecked power. I agree, the full employment mandate should not be with the Fed; it makes more sense to be with with Congress and fiscal policy perhaps.
How does FTPL work in the Eurozone? Debt is issued nationally, currency is supranational.
France is in an increasingly fraught fiscal situation. Germany is relaxing its renowned fiscal stringency. The primary surpluses relative to debt vary by country. To a first approximation the price level must be the same throughout the Eurozone. So how does the price level adjust to equate the real value of the debts of different countries to equal the PV of their primary surpluses?
Q1: The Fed should keep or modify it’s target for average inflation (rate of change of the average price level) according to the size and frequency of sectoral shocks and the heterogeneity in flexibility of prices and wages across products and sectors. The greater the inflexibility and the greater the size and frequency of shocks, the higher the average inflation target should be in order to maximally facilitate changes if relative prices in response to shocks to the end of promoting market clearance in markets/avoidance of unemployment of productive resources.
That the Fed had gotten inflation so close to 2% before the new round tariff and immigration shocks suggest to me that 2% remains a good target.
Q2 Just as 2% is a good target for the size and frequency of background shocks, The Fed should temporarily engineer over target inflation in the event of extraordinarily shocks. How much and for how long depend on the shock and I see not rule for this. And even if the Fed could know how much over-target inflation was needed, there woud still be uncertainty about how to deploy its policy instruments to achieve this. _
My_ guess in hindsight is that the post Covid/Putin inflation was excessive/went on too long and that the Fed should have started raising the EFFR in September 2021 instead of March 2022.
Nice post! It's got all the right questions, if not, perhaps, the right answers. It would be very good for a class like Fischer Black's where you ask PhD students a question, let the discussion unroll, and then give your magisterial answer.
My main thought was a worry that price inflexibility would prefer a 2% inflation target. If you think prices are flexible, though, why not go to deflation and make the penny valuable again, restoring traditional culture?
The mistakes of 2021-2023 pale in comparison to the mistakes of 2004-2008. Inflation was elevated for 4 years spiking at 5.6% in July 2008 and the Fed ignored it because it was CPI and not core PCE. Bernanke was too partisan and like most Republicans of those years and believed Bush was the “right man at the right time” and ignored obvious signs of a dysfunctional economy like a jobless recovery and high illegal immigration and hemorrhaging manufacturing jobs to China and once again elevated CPI.
John, I agree with much/all of what you say here. That said, is it not fair to ask an incoming Fed Chair or Governor (1) additional question? "How effective do you believe monetary policy is - absent a change in fiscal policy - in affecting inflation and unemployment rates?".
My view is that their answer would reveal the extent to which they believe macro variables are fundamentally money-neutral.
1. Remove the full employment mandate from the Fed, whose tools to promote employment are weak and their use generally conflicts with price stability.
2. Yes 0% inflation is achievable but recognize that today’s policy execution takes 12-18 months to affect price levels.
3. Changing federal funds rate has zero impact on current inflation. Pick a number for real rate (adjusted for month to month inflation) and stick to that. Any other policy distorts credit markets unnecessarily.
4. Use FOMC trading to control money supply to stay in synch with GDP. Grow the money supply more slowly than GDP until inflation stabilizes at your goal number. Then allow money supply to grow exactly the same as GDP. Remember you are affecting next year’s inflation rate with this year’s actions. Don’t be afraid to constrict money supply when GDP falter!
The real risk I see is that the Fed is pressured to finance deficits so the politicians don’t have to raise taxes. Banana republic public finance, they say.
I would love to hear much more from Fed on how they incorporate fiscal policy into when setting rates.
Obviously they don’t like disclosing that they would offset the will of elected officials by raising rates when Congress stimulates the economy. Crucial aspect of the job and almost no direct discussion of how they react to stimulus. Clear in the income replacement programs during Covid, if you give ordinary or poor people money, they seem to spend it. You give rich people tax breaks, the save it ( ok maybe invest it ) and so not as stimulative. Ok maybe they spend some but fiscal multiplier much muddier when marginal propensity to consume < 1 for majority of $ involved. Fed clearly has a lot of fiscal responsibility given their authorities.
The management of the balance sheet needs to change. Not new, but Fed changes the net maturity structure of debt via QE. How is this allowed ?
Waller sounding out the Fed duration risk needs to be lower which I welcome. Even at ZLB the duration risk from a more timely recovery and rate normalization is high. Keep the Fed closer to a narrow bank. Agree it’s outrageous TNBs not allowed but Tether is just fine. Only $ stable coins showing large demand as crypto firms still go under banked and also $ stable coin demand subverts AML/KYC banking regs. $ stable coins dominate as most other currencies it’s already easy to launder money( just my opinion ).
PPP fraud and Zoom class excess savings exacerbated inflation. PPP and sibling programs may have both done the most good of a government program and also done the most bad because the $250 billion in fraud was like venture capital for criminal organizations and led to a spike in violent crime and fentanyl deaths. So we know from Clinton’s and Obama’s tax increases that wealthy don’t need tax cuts because the banking system serves them. So wealthy people have no problem getting lines of credit to expand businesses or buy a house and so tax cuts for the wealthy just increase generational wealth.
A defense attorney for the accused never asks a witness for the prosecution a question that he does not already know the answer to. Your list of questions is all over the map. There is no unifying theme, and the answers provided in the second (this) posting are likewise all over the map with no unifying theme.
How would you implement a price-level target monetary policy? Start with the definition of the rate of inflation: inflation = time rate of change of the logarithm of the price level,
i.e., π(t) = dp(t)/dt, where p(t) = logₑ(P(t)). Now, suppose that you, the central banker, have set monetary policy such that P(t) = P* for all time, t, with P*(t) the price level that you have defined as the price level of consumer prices for all urban households. How do you propose to achieve that price level target, P*? If P(t) > P*, π(t) must be negative to return P(t) to P*. Conversely, if P(t) < P*, π(t) must be positive to return P(t) to P*. Obviously, periods of negative π(t) are periods of deflation (not just disinflation), and periods of positive π(t) are periods of inflation. Clearly, no control system that acts with a finite time lag will result in a perfect record of price level stability. There will be drift, and there will be shocks that move P(t) about the target P*. How will you discern when to act? You can implement a monetary policy which allows for small differences, |P(t) - P*| ≤ ε∙P* , with 0<ε≪1, without requiring a monetary policy response, but when the differences |P(t) - P*| > ε∙P*, a monetary policy response to return the price level, P(t), to target P*± ε∙P* is implemented. Now, there are two policy decisions: (1) what is the appropriate positive value of ε, and, (2) what is the appropriate policy response when a monetary policy change is called for? We know how to respond when P(t) < P*- ε∙P* -- we lower the overnight reverse-repo rate for as long as it takes to generate the level of inflation, π(t), that brings P(t) to within the range P*± ε∙P*. That part is standard operating policy. How should monetary policy respond when P(t) > P*+ ε∙P*? It is not enough to bring inflation to zero, π(t) = 0, because the price level targeting policy states that |P(t) - P*|≤ ε∙P* , with 0<ε≪1, is the target price level range. Deflation must be the answer in the case of P(t) > P*+ ε∙P*. How to achieve that? Deflation is not disinflation. It is a severe and prolonged economic recession. How palatible would that be to Congress and/or the Administration in Washington, DC? I'm sure that you get picture. The response would be visceral. "It ain't gonna happen, son." And, there endth "price level targeting" as monetary policy acceptable to the powers that be.
I think that your observations point toward cautious but serious and clearly beneficial reforms. We may be past the point where a conservative approach to reform would be sufficient, yet trying less-disruptive options first would surely improve the situation. The Fed's institutional assumptions are doing enormous damage, especially the acceptance of perpetual 2 percent inflation. That has to stop.
It's funny how people complain about Trump taking power but ignore the Fed. Why should the Fed allow any inflation? Who said they could do that? Who told them to monetize the debt issued by reckless fiscal policy during Covid? Why not let the markets set the interest rates? The Fed has a lot of unchecked power. I agree, the full employment mandate should not be with the Fed; it makes more sense to be with with Congress and fiscal policy perhaps.
How does FTPL work in the Eurozone? Debt is issued nationally, currency is supranational.
France is in an increasingly fraught fiscal situation. Germany is relaxing its renowned fiscal stringency. The primary surpluses relative to debt vary by country. To a first approximation the price level must be the same throughout the Eurozone. So how does the price level adjust to equate the real value of the debts of different countries to equal the PV of their primary surpluses?
Fortunately I have a whole book that answers this question in detail!
https://press.princeton.edu/books/hardcover/9780691271606/crisis-cycle
https://youtu.be/f7pMYHn-1yA?si=-eaXrLgSfihu81jU
https://youtu.be/A_xLOMdGWsU?si=u-02iiJEY87_J29I
Great Suggestions ! ~ falling on deaf ears inside the Fed :)
Meanwhile Ma & Pa Kettle must live with the aftermath :)
https://youtu.be/jSrPlf4GBHc?si=SRWowtxXx1G5WTwS
Bernanke” Monetary policy is 98% talk and 2% action” —- All Narrative, “Forward Guidance”
https://www.brookings.edu/articles/inaugurating-a-new-blog/
Q1: The Fed should keep or modify it’s target for average inflation (rate of change of the average price level) according to the size and frequency of sectoral shocks and the heterogeneity in flexibility of prices and wages across products and sectors. The greater the inflexibility and the greater the size and frequency of shocks, the higher the average inflation target should be in order to maximally facilitate changes if relative prices in response to shocks to the end of promoting market clearance in markets/avoidance of unemployment of productive resources.
That the Fed had gotten inflation so close to 2% before the new round tariff and immigration shocks suggest to me that 2% remains a good target.
Q2 Just as 2% is a good target for the size and frequency of background shocks, The Fed should temporarily engineer over target inflation in the event of extraordinarily shocks. How much and for how long depend on the shock and I see not rule for this. And even if the Fed could know how much over-target inflation was needed, there woud still be uncertainty about how to deploy its policy instruments to achieve this. _
My_ guess in hindsight is that the post Covid/Putin inflation was excessive/went on too long and that the Fed should have started raising the EFFR in September 2021 instead of March 2022.
Nice post! It's got all the right questions, if not, perhaps, the right answers. It would be very good for a class like Fischer Black's where you ask PhD students a question, let the discussion unroll, and then give your magisterial answer.
My main thought was a worry that price inflexibility would prefer a 2% inflation target. If you think prices are flexible, though, why not go to deflation and make the penny valuable again, restoring traditional culture?
The mistakes of 2021-2023 pale in comparison to the mistakes of 2004-2008. Inflation was elevated for 4 years spiking at 5.6% in July 2008 and the Fed ignored it because it was CPI and not core PCE. Bernanke was too partisan and like most Republicans of those years and believed Bush was the “right man at the right time” and ignored obvious signs of a dysfunctional economy like a jobless recovery and high illegal immigration and hemorrhaging manufacturing jobs to China and once again elevated CPI.
John, I agree with much/all of what you say here. That said, is it not fair to ask an incoming Fed Chair or Governor (1) additional question? "How effective do you believe monetary policy is - absent a change in fiscal policy - in affecting inflation and unemployment rates?".
My view is that their answer would reveal the extent to which they believe macro variables are fundamentally money-neutral.