At the Cato Institute Monetary Policy Conference, Part 2

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PANEL 1: WHAT MONETARY POLICY CAN AND CAN’T DO

Moderator: Jon Hilsenrath
Chief Economics Correspondent, Wall Street Journal

Jeffrey M. Lacker
President and CEO, Federal Reserve Bank of Richmond

George S. Tavlas
Member, Monetary Policy Council, Bank of Greece

Manuel Sánchez
Deputy Governor, Bank of Mexico

Panel starts with Hilsenrath introducing Manuel Sánchez.  Argues that monetary policy should have modest objectives.  Takes a conventional view that some inflation is good, that monetary policy is powerful and can deal with macroeconomic problems.  Favors the lender of last resort powers of the Central Bank a la Bagehot.

Monetary policy can best serve markets by not being distracted from the main goals — low inflation and macroeconomic stability.  If monetary policy gets too many goals, it will not achieve its important goals, and may not truly achieve much useful at all.  After all, look at the loose policy prior to the Great Depression, and possibly loose policy prior to the recent financial crisis.

Current policy may be creating financial imbalances now, and lack of incentive for governments to get their own houses in order.

Emerging economies have their own issues with monetary policy, with many cutting rates (DM: competitive devaluation).  Now many emerging economy central reverse those moves, amid rising risks.

Now George S. Tavlas — should monetary policy be based on rules vs discretion?  Taylor Rule makes monetary policy transparent and predictable.  Failure to follow the Taylor Rule 2003-6 led to the financial crisis.  Bernanke argues for freedom.

Asks what would Milton Friedman would do now?  Depends on which Milton Friedman you talk about, as he was a Keynesian (1946) and became a monetarist.  W/Schwartz in 1948, started writing their book on monetary policy.  Their arguments stemmed from the long run effect, versus a short run effect which could be highly variable.  Argued that the collapse of monetary aggregates in 1929-32 led to the Great Depression, and that a simple rule could prevent stupid policymakers.

Friedman felt that feedback policy rules injected too much judgment and discretion, and model risk.

Yet they would be better than raw discretion.  Arthur Burns, teacher of Friedman in the 50s, former Fed Chair, gave into political pressure.  Tavlas thinks that the performance of monetary policy in 90s would favorably dispose Friedman to a Taylor rule.

Cites what Bernanke said to Friedman at his 90th birthday.  Odd comment on how a rule at U Chicago led to Friedman’s marriage to Rose.

Now Jeffrey M. Lacker, President and CEO, Federal Reserve Bank of Richmond.  Argues that monetary policy is undiminished in its ability to affect the price level in the long term.  Ability to affect real variables is limited and transitory.

Argues on a popular view of resource use a la the Phillips curve — that overuse of resources leads to inflation.

Argues that the zero lower bound does not constrain policy now, but that short rates should rise now.  The existing inflation rates may be overly low for random reasons.

Doesn’t think that the increase in the Fed’s balance sheet has any long-term effect on the economy.

Argues for limited goals for monetary policy.

Q&A 1 — Hilsenrath: talk about monetary policy inflation targets. Gold standard, NGDP, etc., should there be a discussion for a new target on monetary policy?

Lacker — present target works well.  Absent a rule a la Taylor other rules will not work well.  Gold standard does not work well, and does not provide price stability.

Hilsenrath — Asset inflation?

Lacker — that should not be a goal for monetary policy.

Tavlas — gold standard had adjustment methods that worked pre-1914.  Unemployment was not a consideration. Union power in the 20s pushed for employment as a factor in monetary policy, and wages would no longer adjust lower.

Argues that when rates were raised to deal with an incipient asset bubble — great depression.  Eventually said that the CPI was a fine goal.

Sanchez also agrees with a CPI goal.  Says it is difficult to spot bubbles, and they may be due to fiscal policies.

Q2 — Mike Mork,  asks about the drop in velocity of M2.  Why?

Lacker doesn’t know.  (Nice honest answer.)  Increase in currency abroad?

Q3 — Lacker says that non-economists are a good influence on the FOMC and a diversity of views.

Q4 — Hilsenrath — Is there a monoculture of views among Ph.D. economists at the Fed.

Lacker — Economists disagree with each other.

Q5 — Josh Crum — what do you do with people bypassing banks in the future?

Lacker — not sure how what the Fed can or should do on that issue.  Has a lot of thoughts, but not so many conclusions.  Mentions repos and money market funds, and the need for maturity transformation.

Q6 — Hilsenrath — should the ECB do more QE?

Tavlas — ECB thinks they can’t affect real variables, but can affect price inflation.

Hilsenrath — but is it working?

Tavlas — takes time for monetary policy to work.  Should eventually work.

Q7 — David Malpass — will the Fed raising rates be stimulative?

Lacker can’t see stimulus.  Can’t see how credit demand would increase even if supply does.

Q8 — Hilsenrath asks how Fed’s moves may affect Mexican monetary policy

Sanchez — Fed creates volatility, with rising rates peso may devalue, and inflation may rise in Mexico, but we will adjust to conditions as the Mexican economy changes.  They will takes foreign monetary policy into account as it affects inflation.

He thinks they have been lucky so far.

Hilsenrath — how does the global slowdown affect your policy?

Sanchez — can’t avoid taking the Fed into account, they are just too big.