Clive Crook should have looked at his notes!

My Bloomberg colleague Michael McKee asked a really good question at Janet Yellen’s press conference Thursday: If the Federal Open Market Committee expects below-target inflation for years, why do most its members think a rise in interest rates before the end of this year is called for?

The headline from the statement was that interest rates are staying at zero for the moment. But among the materials released with the announcement is the so-called dot-plot, which displays each FOMC member’s “judgment of the midpoint of the appropriate target range for the federal funds rate.” This shows that 13 of the 17 participants expect a first rise in interest rates to be warranted before the end of this year.

Turning to another page of the FOMC’s forecast, you see projected inflation remaining below the target rate of 2 percent for three more years — it eventually gets to 2 percent at the end of 2018. On the face of it, even allowing for lags in monetary policy, the prospect of three years of below-target inflation does not argue for an increase in interest rates by December of this year.

…If the Fed doesn’t want to publish a forecast showing inflation rising above 2 percent, it should perhaps acknowledge that its target is indeed a ceiling. And then, having done that, it should perhaps raise the ceiling to 3 percent. 

In 2011

Admittedly, the limits to the Fed’s efforts to stimulate the economy are partly prudential. At the recent meeting of its policy committee, dissenters questioned whether it was right to promise explicitly, as the central bank has, two more years of very low interest rates. Inflation hawks resist the idea of further QE. Here is the central point, however: this is a disagreement about whether further stimulus would be wise, not whether it is possible.

In my view, it is both possible and necessary. The recent revisions to the figures for growth make the economic argument so strong that I wonder if politics is not influencing the dissenters. The problem is that the Fed has to explain itself, both to Congress and to the public at large. Conditions demand what critics would call an “inflationary” monetary stimulus. The Fed’s vague mandate, which calls for both price stability and full employment, is not much help. It is a fight the Fed would rather avoid.

To make the case for new stimulus, the Fed needs better arguments. The past few weeks have settled, to my satisfaction at least, a long-running debate on this very topic. Rather than targeting inflation, central banks should keep nominal incomes growing on a pre-announced path: say 5 per cent a year. Nominal gross domestic product is the sum of inflation and growth in real output – and is the variable that monetary stimulus directly drives.

Monetary policy for the present depression, not for the next recession

At Bloomberg View, Clive Crook has a pretty depressing piece – “Monetary Policy for the Next Recession”:

By pre-crash standards, the big central banks have made and continue to make amazing efforts to support demand and keep their economies running. Quantitative easing would once have been seen as reckless. The official term of art — unconventional monetary policy — tacitly acknowledged that.

But QE isn’t unconventional any longer. It mostly worked, the evidence suggests. The world avoided another Great Depression. Yet even in the U.S., this is a seriously sub-par recovery; growth in Europe and Japan has been worse still. Now imagine a big new financial shock. It’s quite possible that all three economies would fall back into recession. What then?

And concludes:

What if ordinary monetary policy isn’t enough? What if central banks can’t discharge their inflation-target mandate without a hybrid fiscal-and-monetary instrument? QE has already posed that question — it’s a hybrid too — but in a much more subtle way. When the discussion turns to the Fed sending out checks, the issue is impossible to ignore.

It needs to be addressed. Independence for central banks only makes sense if they have the means to do the job they’ve been given. At the moment, they’re dangerously under-equipped.

He shouldn´t be enquiring about monetary policy for the next recession. All should be focused on monetary policy for the present depression”.

It´s amazing how many have been sold on the idea that the Fed is “out of ammo” or, equivalently, “dangerously under-equipped”.

The fact is that the Fed is not working it´s “firehoses” as it could. The only plausible answer to the “puzzle” is “because it chose not to”!

The charts below depict inflation (headline & core PCE) over different periods. This is followed by the chart depicting nominal spending (NGDP) growth (the Fed´s “firehose”) over the same periods.



The “Great Inflation” goes hand in hand with high and rising NGDP growth, i.e., the Fed is “inflaming” the economy.. Thereafter there is the “Volcker-Greenspan Adjustment” leading to the “Great Moderation”, which extends to 2007, a period during which, for much of the time, the Fed provides the “right” amount of “liquidity”.

Bernanke´s Fed thought that amount was “too much”. First, it “closed the taps” and then opened them up but with much less “water pressure”, insufficient for the “spending grass” to grow to heights it had reached during the “GM”!

This very simple story is sufficient to guide monetary policy. First to enable the economy out of the depression and then keeping it from falling into another!