You can (and should) read the entire text of Richard Clarida’s speech delivered today (via webcast) for the Peterson Institute for International Economics. The Federal Reserve Vice Chairman’s remarks are a perfect example of the unnecessary gobbledygook that Economists like him reach for when clarity is warranted.
You’d think after being unable to meet their definitions for their statutory mandate on inflation this would necessarily invite a simple explanation. Then again, as I wrote last week, these suckers are cowards.
Instead, if you had listened in, you’d have heard a bunch of nonsense like this:
This is the second robust evolution of our framework, and it reflects the inherent asymmetry of conducting monetary policy in a low r* world with an ELB constraint that binds in economic downturns. As discussed earlier, if policy seeks only to return inflation to 2 percent following a downturn in which the ELB has constrained policy, an inflation-targeting monetary policy will tend to generate inflation that averages less than 2 percent, which, in turn, will tend to put persistent downward pressure on inflation expectations and, potentially, on available policy space…In other words, the aim to achieve symmetric outcomes for inflation (as would be the case under flexible inflation targeting in the absence of the ELB constraint) requires an asymmetric monetary policy reaction function in a low r* world with binding ELB constraints in economic downturns.
The first “robust” evolution Clarida had earlier referred to in his performance was, also as I wrote last week, the unemployment rate. A simple, “we were wrong to rely so much on it” would’ve sufficed in place of the two-hundred-and-twenty-word long paragraph that obliquely mentioned some reasoning behind changing the monetary policy strategy document from “deviations” in the employment mandate to only “shortfalls” from it.
Economists and policymakers had expected that a tight labor market would’ve bumped up inflation, in light of money-less monetary policy killing for them two economic birds with a single (or four) QE stone. For maybe the last time (thank God), let’s recall what used to be their guiding axiom as I wrote it, mockingly, countless times over the past few years of a LABOR SHORTAGE!!!! that, at the very least, is properly being viewed questionably these days:
One more time for the record book: unemployment rate now at a 50-year low suggests an epically, biblically tight labor market forcing companies to compete, nay fight over exceedingly scarce spare workers, pushing up wage rates at a rapid pace which businesses then pass along to consumers in the form of consumer price inflation.
It would have satisfied both mandates simultaneously, confirming via both inflation and unemployment that true economic growth had been achieved even after the haunting, lingering constraints imposed by the first GFC.
The Fed kept making promises from 2015 forward, making them more forcefully in 2017 and 2018, that wage-driven inflation was going to happen, therefore validating both the recovery narrative and QE by default. This would’ve meant accelerating consumer prices, sure, but also accelerating economic growth for the first time in more than a decade.
It never did. What went wrong? Now what?
Richard Clarida answered with that passage full of ridiculous technical jargon. What he really said was: it’s not our fault, the zero-lower bound (ZLB; or, ELB as they now like to call it; Effective Lower Bound) made things too complicated.
Let me translate. The Great “Recession” (also not our fault) was so bad because of the Global Financial Crisis (that wasn’t our fault, either) which demanded a hugely forceful monetary policy response. In nominal terms, it would’ve meant interest rates being pushed down much further than they could have been because the ZLB was standing in the way.
Ben Bernanke only had 525 bps to work with at its onset, and, looking back on it, maybe the Fed needed 750 bps or a 1000 bps to “properly” offset the GFC and Great “Recession.” Since accommodative monetary policy, if you believe these things, is what contributes to recovery, not being able to introduce the “right” amount of it from the start put the economy into a sort of policy deficit.
What about QE, you ask? That’s what QE was supposed to do, circumvent the ZLB by targeting, essentially, real rather than nominal rates. Inflation expectations, in other words.
As Clarida said, however, inflation expectations were of limited use because the Fed had spent decades positioning itself as an inflation fighter. And because the public and the markets, he implied, see the central bank in that way, the 2% inflation target has come to be viewed as an inflation “ceiling.” Once the economy generates 2% inflation, everyone presumes the Fed will come in and take away the punch bowl – even if it might still be needed.
Which, these people now say, is just what happened; the punchbowl was removed too soon before QE/ZIRP had packed its full punch. The BOND ROUT!!! always lingered just beneath the surface of inflation expectations because, Economists think, bonds are a series of one-year forwards.
Oh yeah, it’s just that stupid. If you follow all the steps and the internal “logic” of it, the Federal Reserve’s Grand Strategy Review boils down to just this: dammit, we’re so successful at this expectations stuff that we actually and repeatedly undermined our own success!
As I wrote a few months ago:
Got that? Their own success had to have been our economic undoing. The bond market, being the bond market and actually discounting future information and perceptions, realized, they claimed, that the Fed was absolutely guaranteed to create recovery, and so began the selling of bonds, pushing higher the risk-free set of rates in anticipation of much better and more profitable opportunities an actual recovery will bring.
But, in doing so, that rush to sell bonds, this BOND ROUT!!!, must’ve short-circuited the recovery itself, choking off economic momentum with rising yields and interest rates.
Wait, wait, wait. That never actually happened, though. As you’re probably muttering to yourself, I don’t recall any such BOND ROUT!!! to begin with. They kept saying it was going to happen, kept assuring everyone that it would, but it never actually did.
In this line of thinking which puts bonds as an instrument of forward expectations, the bond market knew the Fed was an inflation-fighter and therefore began to price forward expectations of higher inflation meaning higher rates which then depressed current activity and inflation instincts. Bonds were looking too far ahead to the punchbowl disappearing. As inflation rose back up toward 2%, expectations of inflation-fighting would restrict the recovery just as it was getting good.
Now the Fed has to fix the “problem” the bond market has introduced; by straight up telling the market and the public that it no longer cares about inflation, therefore yields can stay “accommodatively” low forever. Punch forever!
Let’s sum this up in very simple terms: interest rates are very simple and easy signals for the public to see and react in the way the Fed wants; you, me, businesses, banks, we all start doing more when rates go lower because we all believe that when rates go lower it is inflationary “stimulus”; however, Bernanke was constrained by the ZLB, so he had to use QE which isn’t so straightforward leaving all the world’s dummies (all the world) to react in less predictable fashion; one of those reactions was a hugely inflationary one, too much, which, as we all know, central banks will stomp out inflation once it reaches 2% (acting like a ceiling); therefore, the key to unlocking the successful chain of events is for the central bank geniuses to straight up tell us morons that they’re actually not going to act against inflation this time.
Oh, we’ll all say; since we now know the Fed is going to let inflation go up, stay up, and average out to 2% in the long run, we aren’t going to prematurely spoil their recovery party this time like we did each of the last ten or eleven years. Sorry, Ben, Janet, and Jay, it’s all our fault.
I’m not making this up. Here’s Clarida today saying it in one sentence:
This is especially true in the world that prevails today, with flat Phillips curves in which the primary determinant of actual inflation is expected inflation.
The “flat Phillips curves” he is referring to itself refers back to the unemployment rate problem discussed above. Since they finally realize they can’t count on “full employment” to introduce a cost-push wage inflation component (which shouldn’t just be so easily dismissed since it’s a big clue that their view is missing something) all that’s left for monetary policy is this expectations management alone.
And if people expect the Fed to be an inflation-fighter, and that’s what has held the whole thing back all this time, the way forward is to come out and state for the knuckle-dragging rubes exactly what’s what using terms that they will understand (dense econometric terminology, of course).
There is, obviously, a much simpler and more direct answer. It’s an error in assumption that my co-host Emil Kalinowski wisely flagged on our latest podcast (above) from the updated Strategy document itself:
The inflation rate over the longer run is primarily determined by monetary policy, and hence the Committee has the ability to specify a longer-run goal for inflation.
You can already see the mistake; very simple, a single word. What Milton Friedman (and others) had shown was that in the long run inflation was forever a monetary phenomenon. But if you believe monetary policy is the same thing as money, and thus policy being the same as money the only determinant for inflation in the economy, then you have to go through this exercise of circular logic: people expect a central bank is all powerful and can get whatever it wants; it wants inflation; it hasn’t been able to spark inflation; therefore, lack of inflation must be, despite ZIRP/QE’s, because the central bank didn’t want inflation.
You’d end up blaming the public for mistaking you as an inflation fighter. The public hadn’t been able to notice the difference because of the ZLB, apparently, and that’s why inflation has come up short repeatedly.
Nah. Inflation as a monetary phenomenon, no inflation because there was no money.
This overly complicated argument is really just flat out institutional inertia; when an organization can’t admit to itself, let alone to the public, that it really has no idea what’s going on and what it’s doing. To do so would mean risking the very nature of the bureaucracy, which bureaucracies just don’t do. Instead, hold dear to all the same assumptions that haven’t worked, trying to reverse engineer some (any!) possible chain of excuses which could plausibly leave these sacred founding relics in place.
The much simpler, more direct inflation explanation (one which is actually consistent with the true state of the economy and how bond yields actually work) is that monetary policy is not synonymous with the monetary system. Thus, in Friedman’s terms, if inflation is a function of conditions in the actual monetary system, and the true monetary system is not the same thing as monetary policy, then mistaking monetary policy for monetary conditions will end up making central bankers chase their own tail round and round and round; blaming the public for not appropriately interpreting a complex maze of signals they had laid out.
After all, to put it in the simplest of their own terms: if the primary determinant of inflation is expectations, and markets expect that you can’t generate inflation because you don’t have any money to do so, then…