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August 23, 2012

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Posted: 23 Aug 2012 12:24 AM PDT
David Altig responds (after the release of the minutes from the last FOMC meeting, I'm a bit less pesimistic):
The (Unfortunately?) Consistent Record of the Recovery: Duy and Thoma Respond, by David Altig: Mark Thoma, always generous in linking and reposting our musings here at macroblog, took a look at my last post and read a sense of helpless resignation:
David Altig of the Atlanta Fed argues that "the majority of FOMC participants don't seem to think that the unemployment rate will improve that quickly, but "it is not at all obvious that the pace of the recovery is inconsistent with the FOMC's view of achieving its dual mandate." It sounds as though the Fed has given up -- we've done all that we can, there's nothing more we can do, so we won't even try -- and we're not about to risk even the tiniest bit of inflation to find out if we are wrong (and this is despite assurances from Bernanke and others that the Fed is not out of bullets)...
Tim Duy, whose observations in fact motivated my post, had his own response to my comments:
Altig's calculations make the important assumption that the labor force participation rate holds at 63.7%. This effectively assumes that none of the decline in the labor force participation is cyclical. Instead, it is all structural...
There are really two separate thoughts in these comments. So let me take them in turn, but first recap what I said in the previous post (or at least what I meant to say):
  • Stepping back and looking at the data, I am drawn to the conclusion that U.S. economy looks like it has settled into a pattern of something like 2 percent GDP growth with net job creation somewhere around 150,000 payroll jobs per month.
  • The unemployment projections published in the FOMC participants.' June Summary of Economic Projections (SEP) would, under certain assumptions, be consistent with annual job growth averaging the 150,000 per month pace we have seen over the past year and a half.
The under certain assumptions caveat is obviously important. To Duy's point, my mapping of the apparent employment trend to the SEP unemployment forecasts does assume a constant labor force participation rate. Multiple macroblog posts this year have offered skepticism about exactly that assumption ( here and here, for example), and any rise in the labor force participation rate will require faster job growth to get the same unemployment rate outcomes. But as far as I know—I think as far as anyone knows— participation will rise only if we get that faster job growth in the first place. My only point was that the SEP unemployment rate submissions in June are not obviously out of line with what appears to be the current trend in job creation.
In fact, I cannot tell you what assumptions underlie the unemployment rate (and growth) projections in the SEP. I can tell you only that these are the outcomes the individual participants view as consistent with "appropriate monetary policy." And that brings us to Mark Thoma's concern that the very slow progress toward higher growth and lower unemployment in the SEP implies that the Fed has "given up, "done all that we can," and "won't even try."
I definitively do not want to leave an impression that this view is implied by the SEP. As I noted in my original post (and duly noted in both the Thoma and Duy responses), the definitions of appropriate monetary policy that condition the individual SEP contributions are not spelled out. Lacking that information, one should not infer that monetary policy is assumed by any one individual as fixed or without influence.
Could it possibly be that an unemployment rate at 7.5 percent and GDP growth of 2.8 percent in 2013 (the more optimistic forecasts in the majority, or the "central tendency" range in the June SEP) are consistent with monetary policy having a nontrivial positive impact on the economy?
Of course monetary policy does not operate in a vacuum. As our boss, Atlanta Fed President Dennis Lockhart, said in a speech yesterday:
Monetary policy can exert a powerful positive influence on an economy, but as Chairman Bernanke has pointed out, monetary policy is not a panacea.
I'm not really aware of any models matched to real-world data that suggest monetary policy actions can (at acceptable cost) quickly and completely overcome all of the shocks and headwinds that may present themselves.
You may believe otherwise—that is, you may believe that, for current circumstances, monetary policy is a panacea. Or, less dramatically, you may believe that more monetary stimulus would surely yield something better than what was implied in the June SEP. Fair enough. But you should not believe that lackluster numbers in the SEP tell you anything about individual FOMC participant's views on the efficacy, desirability, or likelihood of further monetary actions, one way or the other.
Posted: 23 Aug 2012 12:06 AM PDT
Posted: 22 Aug 2012 01:32 PM PDT
Tim Duy:
It's All About The Data, by Tim Duy: The minutes of the July 31 - August 1 FOMC meeting are out. In my opinion, they reiterated the importance of the data flow in assessing the Fed's next move.
The money quote was:
Many members judged that additional monetary accommodation would likely be warranted fairly soon unless incoming information pointed to a substantial and sustainable strengthening in the pace of the economic recovery.
At first blush, this can be taken to indicate that easing is imminent, as early as September, in direct contradiction to what I wrote yesterday. The key, however, is how have conditions changed since the last meeting? The next line in the FOMC minutes is:
Several members noted the benefits of accumulating further information that could help clarify the contours of the outlook for economic activity and inflation as well as the need for further policy action.
Recall that as we headed into this meeting, the data had turned particularly weak. The pace of job growth had fallen dramatically from the start of the year, retail sales were flattening out, and GDP growth had slowed to 1.5%. This data combined with the downside risks from Europe raised genuine concerns that more easing was necessary. But they held back, instead waiting to see how the data evolved.
Since then, the data have turned upward, much more consistent with the Fed's medium-term forecast. The July employment report was stronger, retail sales picked up, and overall growth is looking stronger, with Goldman Sachs' GDP tracking estimate rising to 2.3% for the third quarter. In addition, equity markets are on firmer ground as the crisis in Europe has at least temporarily receded. While certainly not exciting, the better tone of the data is palpable. I think the better data influenced Atlanta Federal Reserve President Dennis Lockhart to shift his language away from his dovish July comments. In short, I would argue that the data since the last FOMC meeting has in fact pointed toward an improvement in the pace of the recovery, which I think will pull the middle ground back from the brink of additional asset purchases.
That said, the doves can still make a pretty good case for additional easing, even given the improvement in the data flow. But enough to pull Federal Reserve Chairman Ben Bernanke into their camp? I would guess that the data would pull him away from additional asset purchases as the threat of imminent recession has dramatically faded into the background. We will get a chance to hear his thoughts on recent data at Jackson Hole next week. I don't think he will give an obvious clue; as a general rule, that isn't his style. He will give us the data as he sees it and we will need to figure out what that means for policy.
I would also note that we have plenty of data to chew on between now and September 15th. Notably, we will get another look at the employment situation. Note the pattern of the last two years:
Nfpmom
Start stop, start stop, but on average, not inconsistent with the Fed's forecast as interpreted by David Altig (my response to Altig here). The April-June slowdown in job creation certainly gave the doves the upper-hand, pushing us closer to QE3. A solid August number would give the hawks the upper-hand once again.
There was much discussion about possible additional tools. Communications could change:
One of the policy options discussed was an extension of the period over which the Committee expected to maintain its target range for the federal funds rate at 0 to 1/4 percent. It was noted that such an extension might be particularly effective if done in conjunction with a statement indicating that a highly accommodative stance of monetary policy was likely to be maintained even as the recovery progressed. Given the uncertainty attending the economic outlook, a few participants questioned whether the conditionality of the forward guidance was sufficiently clear, and they suggested that the Committee should consider replacing the calendar date with guidance that was linked more directly to the economic factors that the Committee would consider in deciding to raise its target for the federal funds rate, or omit the forward guidance language entirely.
I like the idea of tying policy to macroeconomic outcomes rather than dates. I think it would remove one source of uncertainty about policy. There was generally support for additional asset purchases, including this:
Many participants indicated that any new purchase program should be sufficiently flexible to allow adjustments, as needed, in response to economic developments or to changes in the Committee's assessment of the efficacy and costs of the program.
I take this to mean that a new program would not be tied down by a specific date or amount, another policy shift I would like to see. Other options were received less enthusiastically:
Some participants commented on other possible tools for adding policy accommodation, including a reduction in the interest rate paid on required and excess reserve balances. While a couple of participants favored such a reduction, several others raised concerns about possible adverse effects on money markets. It was noted that the ECB's recent cut in its deposit rate to zero provided an opportunity to learn more about the possible consequences for market functioning of such a move. In light of the Bank of England's Funding for Lending Scheme, a couple of participants expressed interest in exploring possible programs aimed at encouraging bank lending to households and firms, although the importance of institutional differences between the two countries was noted.
Bottom Line: Lots of possibilities at this point. If you were looking for additional asset purchases at the last FOMC meeting, you were not crazy. There was obviously widespread concern about the mid-year slowdown and its implications for the stability of the Fed's forecasts. Moreover, policymakers appear to have concluded that additional asset purchases could be effective. If the data had continued to progress as it had since the July/August meeting, I would say that another round of QE was a slam-dunk. But the data has not progressed in the same direction; rather than falling short of expectations, it has tended toward upside surprises. That, of course, could change over the next few weeks. In short, we need to ask ourselves what will constitute a "substantial and sustainable strengthening." If Lockhart is a guide, I am thinking we have seen such a shift already. If so, I would expect that on the basis of current data the Fed would delay action until closer to the end of Operation Twist II and to see if Congress has come to any agreement on the fiscal situation in 2013. If the change in the data has not reached the threshold of "substantial and sustainable strengthening" then we would expect action. It will be interesting to see if any of the doves back off on their dreary forecasts in the coming days; such shifts in tone would be telling. Also note that there is a middle ground in the possibility of further changes to the communication strategy; something that could placate both the doves and the hawks until a clearer image of the path of the US economy emerges.
Posted: 22 Aug 2012 12:43 PM PDT
Howard Davies:
Economics in Denial, by Howard Davies, Commentary, Project Syndicate: In an exasperated outburst, just before he left the presidency of the European Central Bank, Jean-Claude Trichet complained that, "as a policymaker during the crisis, I found the available [economic and financial] models of limited help. In fact, I would go further: in the face of the crisis, we felt abandoned by conventional tools." ... It was a ... serious indictment of the economics profession, not to mention all those extravagantly rewarded finance professors in business schools from Harvard to Hyderabad. ...
But it is not clear that a majority of the profession yet accepts [this]... The so-called "Chicago School" has mounted a robust defense of its rational expectations-based approach, rejecting the notion that a rethink is required. The Nobel laureate economist Robert Lucas has argued that the crisis was not predicted because economic theory predicts that such events cannot be predicted. So all is well. ...
We should not focus attention exclusively on economists, however. Arguably the elements of the conventional intellectual toolkit found most wanting are the capital asset pricing model and its close cousin, the efficient-market hypothesis. Yet their protagonists see no problems to address.
On the contrary, the University of Chicago's Eugene Fama has described the notion that finance theory was at fault as "a fantasy," and argues that "financial markets and financial institutions were casualties rather than causes of the recession." And the efficient-market hypothesis that he championed cannot be blamed...
Fortunately, others in the profession ... have been chastened by the events of the last five years... They are working hard ... to develop new approaches...
There is resistance from the old guard, but I'm modestly optimistic. Some people are trying to ask, and answer, the right questions. However, it's a slow process.
Posted: 22 Aug 2012 10:38 AM PDT
Some days it's hard to decide which piece of Republican political hackery is most deserving of ridicule, but this is certainly a contender for today:
Like a Boss, Kevin Williamson, National Review Online
Niall Ferguson should say thank you, because this might take the spotlight off of him (well, until the next time he tries to play economist on the internet).

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