“Euphoria´s in the air

With most people pretty happy with the outcome of the latest FOMC meeting, except of course, Jeffrey Lacker & friends who are all worried about inflation somewhere down the road.

What´s different this time? The wording of the statement says it best (joining two separate strands, my bold):

If the outlook for the labor market does not improve substantially, the Committee will continue its purchases of agency mortgage-backed securities, undertake additional asset purchases, and employ its other policy tools as appropriate until such improvement is achieved in a context of price stability… [A] highly accommodative stance of monetary policy will remain appropriate for a considerable time after the economic recovery strengthens.

As I mentioned in an earlier post, this sounds much like a ‘light’ or ‘no numbers’ version of Chicago Fed president Charles Evans suggestion “that the federal funds rate will not be increased until the unemployment rate falls below 7 percent”.

What nags me is the “automatic brake” of ‘price stability’ (2% inflation). But then, a “highly accommodative stance will remain appropriate for a considerable time after…” confuses me. What if inflation goes up (even temporarily) during the strengthening of the recovery?

An NGDP level target would be a much better “forward guidance” supporting QE. Likely even that in that case the “Chuck Norris” effect would come into play.

The collage below weaves a story. The 1970s NGDP trend was “bad”, characterized by rising and erratic inflation and unemployment. The Volcker years brought the level of NGDP (relative to previous trend) down permanently and allowed it to join up with the “Great Moderation” trend. A “good” trend, characterized by low and stable inflation, low unemployment and stable real growth.

Bernanke´s Fed lost that. The more time goes by, the more permanent is the level loss. The FOMC today, for once, surprised the markets with a more explicit move in the right direction, but I´m not as optimistic as some of my fellow MM´s. This late in the game I think it was still too weak and heavily conditioned on the 2% “magic number”.

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10 thoughts on ““Euphoria´s in the air

  1. Marcus-
    I think it is very positive that the Fed has committed to buying $40 a billion a month in QE in an open-ended program. A big step in the right direction.

    Sure, I want a bigger program, and I want to forget about the 2 percent inflation target for now, and I want no IOR, and I want a far more transparent and explicit Fed.

    But this is a big step in the right direction.

  2. How can open-ended QE be constrained by the price level? If it were so constrained, it would not be open-ended! Besides, Bernanke tied this program’s performance to the labor market, not the price level.

    It seems to me that the announcement of this program has effectively changed the definition of “price stability.”

  3. There is also the conflict of targetting longer term bond yields. Rising long term bond yields should be a signal of success for MM. What are the unintended consequences of preventing this signal working?

  4. My concern is that this QE program is too small, and will be abandoned before it does much good. Then people can say “See? Market Monetarism does not work.”

    Obviously, the Fed did not target NGDP either, only a lower unemployment rate, and then only if inflation stays under control.

    The more I look at this, the more I begin to see Marcus Nunes point of view.

  5. Marcus as far as teh 2% inflation rate he tied it to unemployment-‘price stability consistent with low unemployment’

    It sounds like he’s left himself some breathing room to allow inflation go go over 2$.

  6. The euphoria on my part is from seeing at least some movement away from the hardcore IT at the expense of everything else, and my regret for all of the off color remarks I have made about Bernanke is conditional on him going the full way toward getting the right things done. I do have my reservations, but am willing to see what he does because the journey of a thousand miles always starts with a single step.

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