When Monetary Policy is Guided by “Ghosts”

One of the arguments for acting sooner rather than later on monetary policy is that if the slack disappears, inflationary expectations will surge.

This is an implication of Orphanides latest “Short-sighted monetary policy and fear of liftoff”:

Monetary policy operates with long and variable lags. According to some Fed models, the maximum effect is around two years after a policy action. The Fed has been adding accommodation with quantitative easing up until less than a year ago, which will continue to stimulate the economy and push inflation upward well into 2016.  Policy needs to be pre-emptive. The degree of policy accommodation should be reduced to avoid an overheated economy which would surely destabilise inflation and make a recession more likely (for a more detailed exposition, see Orphanides 2015).

We have all these “unseens” informing monetary policy. The fact is that they are useless. No one knows (or sees) the natural rate, be it of interest, unemployment or output. Furthermore, the uncertainty around their estimates is huge!

To account for that “ignorance” it has become standard to appeal to long and variable lags. However, what if instead of lags, monetary policy operates with leads.

For example, Orphanides says: “The Fed has been adding accommodation with quantitative easing up until less than a year ago, which will continue to stimulate the economy and push inflation upward well into 2016.”

What if we find that even before the end of the taper in October 2014, monetary policy was being “tightened”, despite interest rates remaining at the ZLB?

How could we know? Certainly not by looking at “ghosts” like “slack” or “natural rates”. Bernanke himself has said that to gauge the stance of monetary policy you should look at things such as NGDP growth or inflation.

And those gauges tell us that for more than one year monetary policy has not been “easy” or “accommodative”, quite the opposite!

One-year ahead NGDP growth expectations and medium and long-term inflation expectations are all trending down.

Orphanides Accomodative_1

So are actual NGDP growth and inflation!

Orphanides Accomodative_2

Update: Want to see more evidence of policy tightening? Here goes.

Commodity prices are on a downshute while the dollar is reaching for the stars!

Orphanides Accomodative_3

Today, Lars Christensen tweeted this as “book of the day“. To grasp the evidence given upstairs, it is highly reccommended.Orphanides Accomodative_4

Orphanides, another “interest rates get in all the cracks” advocate


Maintaining zero interest rates for so long is creating a scenario in which containing risks “becomes virtually impossible,” according to an analysis from a former Fed official.

A “muddled mandate” has the Fed too focused on unemployment at the expense of price stability, wrote Athanasios Orphanides, a global economics professor at the Massachusetts Institute of Technology’s Sloan School of Management.

Former Fed boards knew enough to begin raising rates after long periods of accommodation well before the economy hit the full, or “natural,” unemployment rate, said Orphanides, a respected former senior Fed advisor and member of both the European Central Bank and Central Bank of CyprusThe paper outlining his views appeared on the St. Louis Fed website and is based on a June speech he gave to that branch of the U.S. central bank.

In the analysis, he paints a grim scenario should the Fed not choose to start hiking rates soon, calling the current scenario “the case of the missing liftoff.” The unemployment rate, currently at 5.1 percent, equals the 5.5 percent rate that the Congressional Budget Office considered full employment back in February, signaling the Federal Open Market Committee is well behind when previous Feds chose to begin raising rates, he said.

To get past the policy confusion, Orphanides recommends the approach that previous Feds followed, particularly after recessions in 1981, 1990 and 2001.

“The Federal Reserve followed this prudent, pre-emptive approach after every recession in recent decades. This strategy kept inflation in line with reasonable price stability and avoided stop-go cycles and abrupt and costly corrections. Not this time,” he said. “Six years after the end of the Great Recession, the Federal Reserve has yet to begin the process of normalization from the unprecedented monetary accommodation it engineered during and after the Great Recession.

The problem is that they keep calling “unprecedented monetary accommodation” when, in reality, what we´ve seen is “unprecedented monetary stinginess”!

As Friedman said long ago and Bernanke repeated 12 years ago, interest rates do NOT indicate the stance of monetary policy, for that you have to look at things like NGDP growth and inflation!

The charts shows what reasonable (not great) monetary policy was after two of the periods Orphanides mentions. This time, with NGDP growth so “stably” low, there´s no chance of a sustained pick-up in inflation!


But as the first sentence above makes clear, Orphanides, like former Governor Jeremy Stein, is worried about “containing risks” and also like J Stein thinks interest rates “gets in all the cracks”!

Sense & Nonsence

Unfortunately, “nonsense” “gallops ahead”!

Fed’s Bullard Upbeat on Economy, Sees No Need for New Stimulus (Nov 14)

Fed’s Bullard Still Wants Fed Rate Rise in Late First Quarter 2015 (Nov 14)

Fed’s Bullard Still Pushes for First Quarter Rate Rise (Jan 15)

Fed’s Bullard Eager to Raise Rates Soon (Jan 15)

Fed’s Bullard Shrugs Off Inflation Expectations Drop, Favors Rate Rises (Feb 15)

Fed’s Bullard: Delaying Interest-Rate Increase Much Longer Creates Risk (Feb 15)

Bullard: Now May Be Good Time to Start Raising Rates (Mar 15)

Bullard “delirates”:

May 28, 2015 01:03 p.m.

The Federal Reserve should consider new policy options, including directly targeting a non-inflation-adjusted level of economic growth, after more than six years of sustained monetary easing failed to spur a boom, Federal Reserve Bank of St. Louis President James Bullard said.

Bullard not “in a hurry” any longer:

June 3, 2015 05:15 p.m.

It is appropriate to think the Federal Reserve won’t raise interest rates at its June policy meeting following a recent run of weak economic data, Federal Reserve Bank of St. Louis President James Bullard said Wednesday.

But, the “old Bullard” comes back as “Orphanides”:

Mr. Bullard spoke with reporters before Athanasios Orphanides, former head of the Cyprus central bank and an ex-Fed economist, delivered the St. Louis Fed’s annual Homer Jones Memorial Lecture. Mr. Orphanides told reporters he isquite concerned that the Fed is way behind the curve already” in terms of tightening policy.