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The Kocherlakota Shift at the Fed Is a Big Deal...

Narayana Kocherlakota Then: Mike Konczal's Take

August 11, 2011: Mike Konczal: The Fed Dissenters, Or: Examining Narayana Kocherlakota’s Gut:

The Federal Reserve’s FOMC just released another statement punting on both parts of their dual mandate.  Many, including Ryan Avent here, are disappointed… three (three!) dissenters…. Fisher… Kocherlakota, and… Plosser…. What’s their motivation? We looked at Richard Fisher before.  In April 2011 his ”gut tells [him] that [QE2] will result in some unpleasant general price inflation” – something that was absolutely wrong…. But what is going on with Kocherlakota? Why is he dissenting in favor of tightening sooner?  Last time we saw him, he was talking about job openings taking off, numbers that turned out to be exaggerated by modeling assumptions at the BLS.  So that’s off the table. What’s his deal now?  Let’s go to his big discussion paper, Labor Markets and Monetary Policy…. First thing you should notice is that Kocherlakota of the Minneapolis Federal Reserve is basing his opinion on unemployment on an equation in which the Federal Reserve has no role.  Lots of people think the idea that the Fed can’t set a negative interest rate – that there is a “zero lower bound” – has something to do with our current problems.  Agree or don’t, there’s no possible way it impacts this model.  Product markets not clearing doesn’t factor into this model, which is all about how lazy workers are….

All the king’s graduate students and all the king’s junior faculty couldn’t put humpty-dumpty the DMP model of explaining spikes in unemployment back together again.  (p-z) doesn’t have the cyclical component necessary to generate our 9%+ unemployment, and it would have to overcome the massive increase in the u/v unemployment-to-vacancy ratio….

Here’s Kocherlakota, who explains a doubling of the unemployed… as follows….

Given the enormous rise in the benefits of creating job openings, why weren’t firms creating more of them?  A common answer to this question is that firms face “insufficient aggregate demand.”… But the DMP model suggests two other possible reasons…. There are good reasons to believe that expected after-tax productivity p fell. Over the past three years, the U.S. economy has experienced large increases in the federal budget deficits, contributing substantially to the overall federal debt…. What about the utility that a person derives from not working? In response to the recession, the federal government extended the duration of unemployment insurance benefits….Now suppose that, for the reasons just mentioned, p fell by 10 percent in the past three years and z increased by 0.05 during this period. These are large changes, but they are not implausible….

There it is.  Job creators hate future taxes, and unemployment insurance has left our workforce weak, so don’t expect unemployment to come down anytime soon…. ”Now suppose that, for the reasons just mentioned, p fell by 10 percent in the past three years and z increased by 0.05 during this period” is about as close to a “gut” feeling and “gut” reasoning as you can get.  This appears to be how one of the most powerful people in the world for determining the future of the United States’ economy is determining his dissent from Bernanke’s position.

Where to begin?  If unemployment insurance extensions are causing a rampant increase in the time people are unemployed, it should show up in aggregate data. There are a lot of ways to test this – for instance, you could compare the duration of unemployment for those who get unemployment insurance to quits and new entrants – or people that don’t get unemployment insurance. If UI was causing unemployment, you’d see very different results…. And why don’t we assume that “z” has gone up in this recession?  It is harder to find a job than in normal times per week of unemployment duration, outstanding debt loads hang larger over household net worth – having a job seems more important than ever.If you believe that the natural rate of unemployment is near 9% because President Obama has terrified the job creators and the unemployed aren’t starving enough, I am unlikely to convince you otherwise using various forms of econometrics...

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