Stanley Fischer “forgets 1978”

That´s the year Fischer and Dornbusch (and Robert Gordon, independently) introduced by way of macroeconomics textbooks what recently Bob Gordon called 1978 Era Macro. In a nutshell, they put forth the dynamic AS/AD model to study macro fluctuations.

In the first edition of their book D&F have a careful analysis of the effects of supply shocks, and their implication for monetary policy.

Now things have turned upside-down. The supply shock is positive. But that shouldn´t change the analysis. Fischer, like others at the FOMC is nervous about the time span policy has been “accommodative”. So he appeals to the “temporary nature of very low inflation”:

U.S. inflation is only temporarily “very low” due in part to commodity prices, while the U.S. economy has nearly achieved full employment, Federal Reserve Vice Chairman Stanley Fischer said on Monday.

A large part of the current inflation is temporary. It has to do with the decline in the price of oil; it has to do with the decline in the price of raw materials,” he said on Bloomberg TV.

“These are things which will stabilize at some point,” Fischer added, in comments that were careful not to tip his hand on when he thinks U.S. interest rates should rise.

“We are in a situation with … nearly full employment but very low inflation.”

Rates will not stay this low “forever, and we need to be looking ahead as we go,” said Fischer, a close ally of Fed Chair Janet Yellen. Employment has been “rising pretty fast yet inflation is pretty low.”

He said the Fed “would be happier if we saw more physical investment than financial investment” given the monetary accommodation.

Globally, Fischer said the deflationary trend “bothers” the Fed, but is one of many factors the U.S. central bank is watching.

Sounds very much like the utterances of a neophyte policymaker or one that only learned to deal with “too high inflation”! In the case of “too low inflation”, it appears he thinks the economy will naturally take care of it, while ‘we´ll only come in to stop it going overboard!’

And how will he know that the “time has come to step in”? To him (and others) the signaling mechanism is the “nearly full employment and fast rising employment”.

Given that his book with Dornbush has a whole chapter (10) on “The Kennedy and Johnson Years: The New Economics and the Emergence of Inflation”, he should know that monetary policy should not be geared to, let alone guided by unemployment!

The charts indicate that (a) “too low inflation has not been a temporary fact”, even abstaining from oil and commodities; (b) that inflation and unemployment have no close links and (c) it seems that NGDP growth, pretty much under Fed control, is a much better indicator of the stance of monetary policy and the behavior of inflation. Inflation is “too low” despite “fast rising employment” because NGDP growth is “too low”. (Also, the level of NGDP is lower than the “ideal”).

Stan Fischer forgets 1978


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