Blogging a whole conference can be an exhausting affair. Two things I did not expect — sitting in on the press conference with Lacker and Bullard, and blogging the Lunch speaker from the BIS [Bank of International Settlements].
There were a lot of themes that went around. I’ll try to highlight a few of them, and add my own thoughts.
What is the proper mandate for the Central Bank?
The representatives from the Fed generally thought the dual mandate worked well. Most of the critics favored a single mandate of preserving purchasing power of currency, and no mandate of full employment. The reasoning varied there, but as Plosser commented, a dual mandate is what gives the Fed wiggle room to not be rules based, but discretionary. Others commented that the ability of the Fed to affect labor issues is poor.
Plosser also told us to consider the actual text of the dual mandate:
“The Board of Governors of the Federal Reserve System and the Federal Open Market Committee shall maintain long run growth of the monetary and credit aggregates commensurate with the economy’s long run potential to increase production, so as to promote effectively the goals of maximum employment, stable prices and moderate long-term interest rates.”
He said it was interesting how it focused on monetary and credit aggregates as the tools to affect employment, prices, and long interest rates. I had to admit when I heard that, that the dual mandate is better and worse than I thought. Better because it focuses on money and credit as a unit. Worse, because it gives the Fed three disparate targets, and the Fed is bad enough in trying to hit stable prices. It doesn’t need distractions.
Beyond that, most agreed that adding even more targets for monetary policy was a really bad idea — effects on foreign countries, level of the currency, etc.
That said, Borio of the BIS suggested that monetary policy might be better off with a single mandate focusing on growth of liabilities to avoid financial crises, because financial crises cut economic growth severely. This is closer to the way that I think. The Fed should adopt a goal of modesty, and merely try to avoid messing things up, as they did with the flood of liquidity prior to the Great Depression, and in 2003-7.
Aiming for a moderate growth in total liabilities would probably be a better version of Friedman’s idea of a constant growth in M2.
Rules vs Discretion
This one was more agreed. Most favored a more rules-based monetary policy. As noted above, the main argument was over what the rule should be.
Central Bank Independence
There are two questions on Central Bank independence. The first is what are they independent from, and the second is whether they are competent. Over both of those is a question of accountability. Ultimately, they are a creature of Congress, and should be directly accountable to Congress.
As I have pointed out before, the Fed protests actions that compromise their independence, while taking actions to serve the political ends of those they favor. Put more simply, the Federal Reserve, like many nonprofits, is managed for the good of the management of the Federal Reserve. They do that which maximizes their power and resources, subject to risk constraints. This isn’t too surprising — most bureaucracies behave that way.
Are things normal or broken? Did the Fed rescue us, or create a bigger crisis to come?
The Fed governors and a few economists felt that things are mostly normal, while most of the rest felt that things are broken, and a greater crisis could come.
What crises could we face? There are the simple ones, like sending the emerging markets through the shredder. Many noted at the conference how the monetary policy of the big nations travels to the smaller nations under a system of floating exchange rates.
Another possibility is with residential mortgage bonds limited to a few coupons — negative convexity is potentially high. Tightening, if it led to a rise in long rates, could be like 1994, one of the worst years the bond market faced.
More likely is that deflation continues, and the Fed reinforces it with more QE. All of the Fed’s forecasts have erred on the side of rapid growth that has not materialized. As it is, with demand growth limited, we continue to bump along the bottom with ZIRP, with the Fed’s balance sheet growing bit by bit.
What will happen when Fed tightens?
Maybe not much. Maybe too much. It will be interesting to see how how banks and money market funds react to slightly higher rates. I lean toward the “maybe not much” if/when they tighten. I’m still not convinced that the Fed will tighten, simply because they have let a lot of little mini-crises derail them from what could be a more important task — that of normalizing the yield curve. What will go “boo” next week?
Four Final Notes
- The Fed should not do fiscal policy, or quasi-fiscal policy. The Fed is less effective at its main task of monetary policy because they go after areas outside the core of what they have to do: buying MBS rather than Treasuries only, buying long Treasuries rather than short Treasuries, and being a financial & systemic risk regulator. A monetary policy that is not aggressive will avoid systemic risk… but the Fed went too far many times in easing policy, and not far enough in tightening policy when it was needed.
- The session on the “knowledge problem” was interesting and right, but it is basically the problem that any bureaucrat runs into. So long as you have regulation, the knowledge problem will exist. That said, you didn’t need to have this session at a monetary policy conference, because the problem is not unique to monetary policy.
- Hilsenrath took up an argument of mine about the Fed — it is an intellectual monoculture of neoclassical economists. Lacker argued that neoclassical economists often disagree with each other, so it’s not a problem. It *is* a problem, though, because the methods don’t lead to good forecasts, and thus good policy.
- I think the Fed needs to revisit their models, and think more broadly — labor use is getting affected by demographics, technology and global trade. These factors aren’t going away, and they are resulting in a permanent reduction in opportunities for the lesser-skilled areas of the workforces in the developed world, until the whole capitalist world is developed, and wage rates finish equalizing globally.
What should the Fed expect? Its ideas are flawed at their core as the world has changed, and closed-economy macroeconomics don’t apply well. Their efforts to change tinker at the edges, and don’t realize their tools aren’t effective. Better to set modest goals for monetary policy of a stable price level with no debt bubbles. That is achievable, and it is better to do what you can do well, than attempt things beyond your ability.