Karl Smith Is Shirll
A Task I Have Failed At...

The Federal Reserve Responds to Political Pressures

Kash Mansouri:

The Street Light: How the Inflationistas Have Shaped Fed Policy: [A]ny concern about inflation by the Fed right now is a bit ridiculous. In fact, the more "hawkish" Bernanke on the topic of further expansionary actions by the Fed seems at odds with the Fed's own data and projections. Most significantly to me, it also seems at odds with Bernanke's remarkably detailed and perceptive explanation of exactly why he finds the long-term unemployment problem to be so very "distressing":

BERNANKE: You're absolutely right. Long-term unemployment in the current economy is the worst, really, the worst it's been in the post-war period. Currently, something like 45 percent of all the unemployed have been unemployed for six months or longer. And we know the consequences of that can be very distressing, because people who are out of work for a long time, their skills tend to atrophy; they lose contacts with -- with the labor market, with their other people working, the networks that they have built up. Very concerning.

These are not the remarks of someone who doesn't care about the plight of the unemployed. And this not is the sort of detailed description of the permanent harm that unemployment wreaks on individuals that we would typically expect from someone who's principally worried about inflation. So why the talk about the potential dangers of inflation?

I believe that Bernanke's references to the Fed's "dual mandate", and most importantly, the hard reality confirmed in this press conference that there will be no further easing by the Fed, are the direct result of politics, not economics. The noise that has been generated about the Fed's expansionary actions over the past 3 years is substantial, and has only gotten louder in recent months. This has not gone unnnoticed within the Fed. Some loud voices in the business press, as well as many prominent politicians (mostly Republican), have been squawking incessantly about the awful dangers (imaginary though they may be) of the Fed's expansionary policies. And I think that this, unfortunately, has had a direct impact on Fed policy.... [W]e are seeing a Fed that is sensitive to the political winds swirling around its actions... the inflationistas out there have had a real impact on Fed policy -- not because they have good economic arguments, but because they have a frightening amount of political power. And perhaps that should be the most concerning thing of all.

Ryan Avent:

Monetary policy: Will the Fed let America catch up?/a>: [T]here are two potential ways to approach a monetary policy target: rate-targeting and level-targeting.... One thing that makes dovish writers uncomfortable with the increasing emphasis on controlling inflation is just how far both the price level and the level of nominal output have fallen below their long-run trends. Here's the core price level.... At this point in recovery, the growth rates of both inflation and nominal GDP are approaching trend levels (though they're not quite there yet). But a return to trend growth in output leaves the economy substantially, and perhaps permanently, below potential its potential level of output. That gap more or less corresponds to your employment problem.

The solution to the problem, of course, is a period of catch-up. But to return to the trend output level would require a period of above trend output growth, which would probably necessitate a period of above-normal inflation.... Now, just because the Fed isn't actively working to accelerate inflation from the current pace by initiating QE3 doesn't meant that it won't tolerate a period of catch-up. We can't get a real (ha) sense of what the Fed is prepared to accept until the tightening process begins. Unquestionably, an effort to prevent any increase in inflation above 2% would represent a too-tight policy stance, and it would be right to rhetorically flay the Fed in that case.

I've argued before that the Fed should have couched its second round of asset purchases in an open-ended fashion, with an eye to hitting a level target, so that it wouldn't face huge questions about the direction of policy when it hit some arbitrary threshold for purchases. But that ship has sailed....

Catherine Rampell draws attention to a moment in yesterday's press conference I neglected to mention. Asked about the Reinhart-Rogoff evidence on slow recoveries after financial crises, Mr Bernanke answered that he appreciated their empirical findings but did not necessarily accept a causal relationship. Rather, he indicated that slow post-crisis recoveries may be the a product of an insufficient policy response. In that it seems he may agree with my take on post-crisis recoveries: that when the central bank itself doesn't cause the recession by tightening policy, there will often be little room to loosen before hitting the zero lower bound. And while the zero bound may not bind in a technical sense, it does appear to bind in a psychological sense. In other words, when the central bank doesn't generate the recession, it's often reluctant to fight the downturn aggressively enough.

Paul Krugman:

The Intimidated Fed: Last month more than 14 million Americans were unemployed by the official definition — that is, seeking work but unable to find it. Millions more were stuck in part-time work because they couldn’t find full-time jobs. And we’re not talking about temporary hardship. Long-term unemployment, once rare in this country, has become all too normal: More than four million Americans have been out of work for a year or more. Given this dismal picture, you might have expected unemployment, and what to do about it, to have been a major focus of Wednesday’s press conference with Ben Bernanke, the chairman of the Federal Reserve. And it should have been. But it wasn’t....

The Fed normally takes primary responsibility for short-term economic management, using its influence over interest rates to cool the economy when it’s running too hot, which raises the threat of inflation, and to heat it up when it’s running too cold, leading to high unemployment. And the Fed has more or less explicitly indicated what it considers a Goldilocks outcome, neither too hot nor too cold: inflation at 2 percent or a bit lower, unemployment at 5 percent or a bit higher. But Goldilocks has left the building, and shows no sign of returning soon. The Fed’s latest forecasts, unveiled at that press conference, show low inflation and high unemployment for the foreseeable future. True, the Fed expects inflation this year to run a bit above target, but Mr. Bernanke declared (and I agree) that we’re looking at a temporary bulge from higher raw material prices; measures of underlying inflation remain well below target, and the forecast sees inflation falling sharply next year and remaining low at least through 2013. Meanwhile, as I’ve already pointed out, unemployment — although down from its 2009 peak — remains devastatingly high. And the Fed expects only slow improvement, with unemployment at the end of 2013 expected to still be around 7 percent.

It all adds up to a clear case for more action. Yet Mr. Bernanke indicated that he has done all he’s likely to do. Why?...

The only way to make sense of Mr. Bernanke’s aversion to further action is to say that he’s deathly afraid of overshooting the inflation target, while being far less worried about undershooting — even though doing too little means condemning millions of Americans to the nightmare of long-term unemployment.... Mr. Bernanke is allowing himself to be bullied by the inflationistas: the people who keep seeing runaway inflation just around the corner and are undeterred by the fact that they keep on being wrong....

I’d say that the Fed’s policy is to do nothing about unemployment because Ron Paul is now the chairman of the House subcommittee on monetary policy.

So much for the Fed’s independence. And so much for the future of America’s increasingly desperate jobless.