Comments on: A Question from a Commenter

By: PJG

PJG — Wed, 10 Dec 2014 14:51:51 +0000

This may be true, but I’d be more inclined to believe it if the Fed were currently doing the following things that are well within normal and responsible central banking behavior:

1) Link all policy announcements to their objective so the public and financial markets are clear about what the objective is. For example, we should hear things like “The FOMC is committed to achieving its 2% inflation target and will do everything within its power to achieve that goal…” every time they release minutes.

2) Cut IOER to 0% (or even lower as has been tried in Sweden)

3) Continue bond buying (working their way up to longer and longer maturities)

By: PJG

PJG — Tue, 09 Dec 2014 21:08:28 +0000

That’s a good point. The Fed alleges that it wants 2% inflation and has undershot this target for roughly half a decade. Even worse, market based inflation forecasts (from the Cleveland Fed) indicate below 2% inflation for the next 10 years. As far as I can tell though, Kocherlakota is the only FOMC voting member who seems to take the 2% target seriously and is also the only one that I recall to have dissented in favor of more expansionary policy recently. I am becoming more convinced that the Fed has other priorities that evolve over time and that it treats the 2% “target” as a ceiling and is satisfied with anything between 0 and 2%. They are (still) a discretionary monetary regime that has neither a precise nor a stable objective.

On the other hand, I’m fairly persuaded by the evidence from Canada, New Zealand, and the UK that a strong commitment to a nominal target can be achieved in the medium to long run.

By: handle

handle — Tue, 09 Dec 2014 12:40:55 +0000

Another way to say this is that the Fed may genuinely want a certain goal, and they may be honest when they claim that they are able and willing to do whatever is necessary to achieve it, but actually, they are super squeamish about playing in the necessary asset classes, and they are in error in thinking they can do without them. In other words, they are more committed to relying exclusively on conventional policy tools that can be saturated, than they are to actually achieving their goals, and when they fall short, they are wrong about why.

To an outside observer, that makes the whole system look impotent and ineffective, with no correlation between policy and results.

By: Handle

Handle — Mon, 08 Dec 2014 18:12:08 +0000

Maybe part of the impotence of the Fed is that they are restricting themselves to certain asset classes in which money printing (or reverse-repo or whatever), will not be sufficient to have the intended effect, because the markets are already ‘saturated’.

If all you are buying is bonds, then maybe the market is so saturated that you can run out of bonds. The government’s expenditures of the new cash is not enough to bid up prices enough. Or a lot of that cash ends up stuck in excess reserves and isn’t bidding up prices either.

If the Fed instead also bought futures, say, contracts for future delivery of goods that closely resemble the CPI or PCE baskets (or maybe NGDP at large), then they should be able to bid those contracts up to whatever inflation path they want.

Sure, they can saturate the near-to-maturity markets first, because there isn’t enough time to adjust. But if they start bidding up longer-term futures, they are going to signal extra demand that brings extra supply into the market.

They will be taking more risk, but they will also be operating in a space that is much more elastic, and much more likely to actually achieve their rate path goals.

By: Arnold Kling

Arnold Kling — Mon, 08 Dec 2014 17:18:27 +0000

I would be impressed if the Fed were to say that its inflation target is 1 percent above recent inflation and inflation proceeds to increase by 1 percent. Over the last few years, that has not happened.

You asked a spmewhat different question, about moving inflation expectations in the market. It is more difficult to think about data in that context, because in an efficient market the market is trying to anticipate the Fed. So defining a “Fed action,” and in particular an “unanticipated Fed action” is hard.

By: PJG

PJG — Mon, 08 Dec 2014 15:27:12 +0000

OK thank you, that clarifies it. You think it is possible (likely?) that the central bank is incapable of moving inflation forecasts (and therefore the TIPS spread) up a percentage point. Fair enough. Next question, what kind of data would cause you to reduce the probability you assign to this possibility?