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Four Lessons the
Federal Reserve Ought
to Have Learned
J
. Bradford DeLong
U.C. Berkeley
Economics and Blum Center, WCEG, and
NBER
http://bradford-delong.com
brad.delong@gmail.com
@delong
2018-07-25
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624 words
At least as I see the world, the past 20 years have taughtâor ought to have
taughtâthe Federal Reserve four lessons. Yet its current policy posture
leads me to wonder whether it has internalized any of them.
The ïĴ rst lesson is that, at least as long as the current interest rate
conïĴ guration is sustained, the proper inflation target is 4
%
per year rather
than 2
%
per year. That is essential in order to have enough running room
to make the 5
%
-point or larger cuts in short term safe nominal interest
rate usually called for to properly cushion a recession when it hits the
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economy. The Federal Reserve protests that to change its inflation target
even once lose it credibility. But why is worth having credibility that you
will stick to a policy that deprives you of the ability to do your proper job?
The second lesson is that the two slope coefïĴ cients in the algebraic
equation that is the Phillips curveâthe gearing between expected inflation
and current inflation, and the responsiveness of future inflation to current
unemploymentâare both much smaller than they were back in the 1970s
or even in the 1980s. Alan Greenspan recognize this in the 1990s. He then
rightly judged that pushing for faster growth and lower unemployment
was not taking excessive risks but rather harvesting low-hanging fruit. The
current Federal Reserve appears to have a different view.
The third lesson is that yield curve inversion is a sign not just set the
market thinks that monetary policy is too tight, but that monetary policy is
actually too tight. The people who bid up the prices of long-term
Treasuries in anticipation of rate cuts when the Federal Reserve oversteps
and triggers a recession are the same people who are now on tenterhooks
wondering if this month is the month to start cutting back on investment
plans because a recession will soon produce overcapacity. The Federal
Reserve today has a "habitat theory" about why this time it is different,
and a yield curve inversion would not mean what it has always meant. But
2006 was suppose to be a time when it was different too. History teaches
us that it is highly likely that this time it is not different, but rather the
same.
The fourth lesson is that, for the past three and a half decades, the
principal shocks hitting the macroeconomy have not been inflationary
shocks likes the 1973 and 1979 oil crises, but rather deflationary shocks
like the 1990 S&L crisis, the 1997 Asian crisis, the 2000 dot-com crash,
9/11, the 2007 subprime crash, and the 2010 European debt crash. Back in
the 1980s it was not unreasonable to argue that the next large shock was
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likely to be an inflationary one. It is much more difïĴ cult to reasonably
argue that today.
Janet Yellen told me back in the 1990s that, in her estimation, conducting
the Federal Reserve internal debate in the framework of interest-rate rules
had greatly increased the ease of getting from agreement about the
structure and state of the economy to a rough consensus on appropriate
policy.
But, at least as I see it, right now the Federal Reserve's process of getting
from a realistic view of the economy to a policy does not seem to be
functioning well. Perhaps it is time for the Federal Reserve to place its
internal discussions in a more explicit frameworkâan optimal control
framework, perhaps?
----
#projectsyndicate
#monetarypolicy
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