# Cynics galore

Tim Duy has a post – On the logic of inflation hawks. There´s not much “logic”, it´s pure cynicism. On this matter I think Kocherlakota gets “The Greater Cynic” Prize. A review of some of his recent manifestations:

August 17 2010

Of course, the key question is: How much of the current unemployment rate is really due to mismatch, as opposed to conditions that the Fed can readily ameliorate? The answer seems to be a lot. I mentioned that the relationship between unemployment and job openings was stable from December 2000 through June 2008. Were that stable relationship still in place today, and given the current job opening rate of 2.2 percent, we would have an unemployment rate of closer to 6.5 percent, not 9.5 percent. Most of the existing unemployment represents mismatch that is not readily amenable to monetary policy.

Long-run monetary neutrality is an uncontroversial, simple, but nonetheless profound proposition. In particular, it implies that if the FOMC maintains the fed funds rate at its current level of 0-25 basis points for too long, both anticipated and actual inflation have to become negative. Why? It’s simple arithmetic. Let’s say that the real rate of return on safe investments is 1 percent and we need to add an amount of anticipated inflation that will result in a fed funds rate of 0.25 percent. The only way to get that is to add a negative number—in this case, –0.75 percent.

March 25 2011

The bubble collapse has no impact on unemployment or output, given sufficiently accommodative monetary policy.

March 31 2011

If you make the assumption that at the end of 2010 that policy was appropriately accommodate, so neither too loose nor too tight, then you see core inflation go up by 50 basis points over the course of 2011, the usual response to that we know from 20 years of thinking about monetary policy or even more is to raise the target rate by even more than that increase in observed inflation. So that would mean you should raise your target rate by more than 50 basis points. The usual number is a 1.5 coefficient that Taylor has, so that would be 75 basis points. So this is saying that if you take monetary policy as being appropriate, just right at the end of 2010, then at the end of 2011 if you see this increase in inflation you should be responding to it by raising rates.

Other cynics include Bullard, Andolfatto and Steve Williamson, all “surveyed” in this post. Lacker is well reviewed by Tim and appears to be intent on “grabbing the prize” from Kocherlakota. I reproduce some of Tim´s graphs and complement them with additional ones that cover Lacker´s “hope for more unemployment “.  From Lacker, a beautiful tour de force. Watch how he switches from core to headline inflation with “effortless ease”:

In the last cycle, the economy began to grow more rapidly at the end of 2003. Although energy prices showed growth spurts, unemployment had not yet begun to fall and the core inflation measure that excludes energy and food prices was still just 1-½ percent. As a result, many forecasters expected inflation to diminish, and the FOMC kept the funds rate at a very low level well into 2004. Instead of falling, overall inflation soon rose to 3 percent, where it stayed, on average, through the end of the expansion in 2007. Core inflation averaged 2-¼ percent over that horizon. With hindsight, I think it is fair to say that policymakers overestimated the extent to which high unemployment would keep inflation from accelerating, and as a result, waited too long to withdraw monetary stimulus. Four years of 3 percent inflation may not have been the worst of all possible outcomes, but I do not consider it a success. I hope we do better this time. In particular, I believe we need to heed the lesson of the last recovery that inflation is capable of rising even if the level of economic activity has not returned to its pre-recession trend.

The picture follows.

Tim puts up the graph for one commodity price representative – Crude materials for further processing. I add another two price indices in the “commodity” category: The PPI-all commodities and the CRB from the Commodity Research Bureau. Common to all three is the “take off” after 2001. In this post I argued that that pattern was due to the ballooning Chinese imports, heavy in commodities – that increased by a factor of 7 from 2001 to 2010 – following its membership in the WTO in December 2001. Mr Lacker, in order to avoid the rise in headline prices, think about expelling China from the WTO! The Fed can´t do anything about it. Worse, when it tried to do so in 2008 – remember that your colleague Richard Fischer voted for a rate increase as late as the August 2008 FOMC meeting – things got out of hand, to put it mildly.

Mr. Lacker, you say that the economy began to grow more rapidly in late 2003. Yes, you are correct. As the following picture shows that was due to the fact that nominal spending began to rise sufficiently strongly in order to close the “gap”, which it did by the end of 2005. It is clear why unemployment fell from that point. In other words, monetary policy was correct. Your idea would have made things worse, probably anticipating the start of the “Great Recession”.

This last picture indicates the depth of the “hole” the economy is in and you seem eager to “tighten” monetary policy. I´m sorry to say, but you most certainly do not deserve a place at the FOMC.

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