Monday, August 29, 2016

Larry Summers is going to be writing a lot on CBs and fiscal policy failures

Larry Summers - disappointed by what came out of Jackson Hole. Quote:

I had high hopes for the Federal Reserve’s annual Jackson Hole conference.  The conference was billed as a forum that would look at new approaches to the conduct of monetary policy—something that I have been urging as necessary given secular stagnation risks and the sharp decline in the apparent neutral rate of interest.  And Chair Yellen’s speech in a relatively academic setting provided an opportunity to signal that the Fed recognized that new realities required new approaches.

The Federal Reserve system and its Chair are to be applauded for welcoming challengers and critics into their midst.  The willingness of many senior officials to meet with the Fed Up group is also encouraging.  And its important for critics like me to remember that the policy explorations of today often become the conventional wisdom of tomorrow.   In this regard the fact that the Fed has now recognized that the decline in the neutral rate is something that is much more than a temporary reflection of the financial crisis is a very positive sign.

On balance though, I am disappointed by what came out of Jackson Hole judging by press reports since I was not there.  First, the near term policy signals were on the tightening side which I think will end up hurting both the Fed’s credibility and the economy.  Second, the longer term discussion revealed what I regard as dangerous complacency about the efficacy of the existing tool box.  Third, there was failure to seriously consider major changes in the current monetary policy framework.


Additional points that I would have thought appropriate in commenting on near term policy include: (i) with current estimates of the real neutral rate running near zero and there being a downward trend it is far from clear that current policy is highly expansionary. (ii) It is plausible that hysteresis effects account for some of the decline in productivity growth and that if so allowing for rapid demand growth might have lasting supply side benefits. (iii) if a two percent inflation target was appropriate when the neutral real rate was thought to be two percent and stable, surely a higher target is appropriate when the neutral real rate is zero and unstable. (iv) in contrast to the risks of inflation exceeding two percent ,which are likely very small, the risks of a downturn are very serious. (v) the apparent rigidity of inflation expectations and insensitivity of inflation to measures of slack create extra uncertainties about the conventional idea that unemployment rates in the 4.5 percent range risk accelerating inflation.

As an aside, why shouldn't a zero inflation expectation be normal in this day and age? Fiscal conservatism has won, labour bargaining power has been eliminated, and the Fed has spent 35 years jacking up rates whenever inflation has shown up.

Don't 35 years of policy mean anything to inflation expectations?

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