Stanley Fischer speaks with forked tongue

A James Alexander post

In a speech this week Stanley Fischer, Vice Chair of the Fed, insisted on the existence of the Phillips Curve. It made little sense.

  1. Inflation and unemployment: Estimated Phillips curves appear to be flatter than they were estimated to be many years ago–in terms of the textbooks, Phillips curves appear to be closer to what used to be called the Keynesian case (flat Phillips curve) than to the classical case (vertical Phillips curve). Since the U.S. economy is now below our 2 percent inflation target, and since unemployment is in the vicinity of full employment, it is sometimes argued that the link between unemployment and inflation must have been broken. I don’t believe that. Rather the link has never been very strong, but it exists, and we may well at present be seeing the first stirrings of an increase in the inflation rate–something that we would like to happen

If, after more than 50 years since it’s invention the curve may be still be flat or horizontal then it would seem to non-economists that it is time to move on. He made many jokes and recalled many  supposedly wise sayings, but one appeared to me to demonstrate why the profession of economics is held in such disrepute.

But Paish also warned us that forecasting was difficult, and gave us the advice “Never look back at your forecasts–you may lose your nerve.” I pass that wisdom on to those of you who need it.

It seems to typify economics as a profession, never let your theories be tested. Real scientists would say if your forecasts are consistently proven wrong then your models are wrong.

The final comment in that Inflation and Unemployment section is what struck me as particularly disingenuous. How does the Fed demonstrate that they want to see the inflation rate increase? By actively tightening monetary policy in December 2015?  By having so publicly forecast and fretted about a rise in inflation for months beforehand, thus passively tightening monetary policy? It appears that Fischer says he wants something but all his actions and his fretting tells the market that he doesn’t actually want it.

Fischer’s Fed has consistently forecast a return to higher inflation as unemployment has fallen. It hasn’t happened, it will never happen if the Fed insists on tightening any time 2% is approached, either in real time or more importantly in the Fed’s own forecasts for inflation.

His attitude to inflation was quite revealing when he was asked in the Q&A, about 42 minutes in, whether raising the inflation target to 4% was a good idea.

He immediately responded by talking about other countries’ hyperinflation experiences. Great. Scare tactics. ‘If you touch the 2% target all hell would break loose.’ Really?

Then he worried about too much indexation at higher rates of inflation and how hard it was to undo that indexation once embedded. A fair point, but not very relevant in a free market economy. Indexation is a supply side issue, and not really one for central bankers to address, though they may have to react to it once it is established.

He then said that 2% is  about right, “clearly here”, according to Greenspan’s definition of not having people having to think about the rate of inflation in their daily work. And “4% is the other side of the line”. Is there really such a difference? Was the average of 2.5% PCEPI throughout the Great Moderation so bad?

And lastly he mentioned the “credibility problem of changing targets in mid-stream, because that’s easy”. It’s easy, perhaps because it’s right.

In a section on the ZLB and the effectiveness of monetary policy he stated:

Empirical work done at the Fed and elsewhere suggests that QE worked in the sense that it reduced interest rates other than the federal funds rate, and particularly seems to have succeeded in driving down longer-term rates, which are the rates most relevant to spending decisions.

The Fed has claimed that is the reason they did QE, to bring down longer-term rates, but they keep missing the Fisher effect. If QE is really working then it is raising longer term rates, reflating the economy. Fischer and the Fed have a truly massive blind spot here, one that makes their policy making hard to understand in the markets.

And that is what we saw when QE was working, and growth expectations rising, longer-term rates were rising too, not falling. From an old post:

JA Stan Fischer

At least Lael Brainard, on the same day, spoke  more sense. Is there a generational debate at the Fed? The old guard of inflation hawks and those younger types more in touch with the lack of prosperity in the US. We hope so, although age shouldn’t be the main gauge for hawkishness. There are lots of older Market Monetarists too!

3 thoughts on “Stanley Fischer speaks with forked tongue

  1. Excellent post. Verily, the slide from 1.3% inflation to hyperinflation could happen in a flash. And once at 2.01% inflation the Fed will have to cause a recession to get prices back under control.

  2. Bernanke makes a similar comment in The Courage to Act regarding using QE to LOWER long term rates. My notes aren’t clear, but I think he says that around pages 378 or 379. It’s reminiscent of Greenspan talking oftentimes in the mid 2000s about the “conundrum”. I never understood what he was talking about. Why would each extremely well communicated quarter point increase in the FFR be expected to move the rate in 10 year Treasuries? The much harder to understand conundrum is why the Fed would want to tighten when 10 year T’s are paying less than 3%? (let alone when they’re paying less than 2%!).

  3. Pingback: FOMC splits, and it is a good thing! – NGDP Advisers

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