I have been promising myself to write about the state of the policy discussions of policies toward CO2 accumulation in the atmosphere and to give monetary policy a rest, but and they say, “no rest for the wicked.” Given how MUCH I post (and spar with people on “Notes”) I can hardly continue to put off commenting on Powell’s Jackson Hole speech and the new Framework .
Not that there is a scarcity of opinions already among which I’ll highlight from Substack, Claudia Sahm (1), Robin Brooks, Vitor Constancio, Scott Sumner, David Beckworth, Veronique De Rugy Claudia Sahm (2)
Sahm 1
In discussing the new Framework Sahn correctly begins with an examination of the existing one. The Fed’s Congressional mandate -- stable prices, maximum employment, moderate long-term interest rates – has not changed. Any framework is about a) how to interpret the objectives b) how to reconcile the tradeoffs among them c) how to return to desired reconciliation when away from reconciliation.
The 2020 Framework formally adopted a 2% p.a. increase in the index of personal consumer expenditures (PCE) as the inflation target. It did not explain, but presumably took into consideration that inflation (or deflation) has costs and benefis.
a) It changes the outcome of negotiated term contracts and therefor makes it more difficult to negotiate mutually beneficial long-term agreements and to formulae long-term plans. Even if the average inflation/deflation coud be correctly predicted, greater inflation/deflation would create more variance of the components.
b) Prices can never be fully flexible, but even if prices are symmetrically inflexible there is more potential for upward variance in inflation than downward variance of deflation.
c) Deflation, however, has an additional cost. When more prices (or wages) are asymmetrically downwardly inflexible, deflation will cause those markets not to clear – unemployment of resources.
There was no discussion of what to do when inflation is above or below target
Sahm also reasonably points out that a revision of the 2020 Framework is timely. A lot has happened.
“The … framework in 2020 rested on the assumption that the low-inflation, low-interest-rate environment that followed the Global Financial Crisis in 2008 would persist.”
Unfortunately, this is unclear because the “environment” is itself partly a result of Fed decisions. What is being assumed about exogenous variables. The Framework did not specify them:
“Employment, inflation, and long-term interest rates fluctuate over time in response to economic and financial disturbances. Monetary policy plays an important role in stabilizing the economy in response to these disturbances. The Committee’s primary means of adjusting the stance of monetary policy is through changes in the target range for the federal funds rate. The Committee judges that the level of the federal funds rate consistent with maximum employment and price stability over the longer run has declined relative to its historical average. Therefore, the federal funds rate is likely to be constrained by its effective lower bound more frequently than in the past. Owing in part to the proximity of interest rates to the effective lower bound, the Committee judges that downward risks to employment and inflation have increased. The Committee is prepared to use its full range of tools to achieve its maximum employment and price stability goals.”
Let’s parse that:
Employment, inflation, and long-term interest rates fluctuate over time in response to economic and financial [“shocks”]. Monetary policy plays an important role in stabilizing the economy [achieving maximum employment and price stability over the longer term] in response to these shocks. The Committee’s primary means of adjusting the stance of monetary policy is through changes in the target range for the federal funds rate (EFFR). The Committee judges that [becasue of X, Y, and Z] the level of the federal funds rate consistent with maximum employment and price stability over the longer run has declined [Why declined?] relative to its historical average. Therefore, the federal funds rate is likely to be constrained by its effective lower bound more frequently than in the past owing in part to the proximity of interest rates to the effective lower bound. [Therefore,] the Committee judges that [unless the Committee is prepared to use its full range of tools to achieve its maximum employment and price stability goals], downward risks to employment and inflation have increased.
Sahm remarks that the _way_ the Fed intended to _use_ its full range of tools was “to increase inflation to its 2% target, such as allowing a period of modestly above-target inflation or unusually low unemployment without raising rates.”
But this remains unclear. “A period of modestly above-target inflation or unusually low unemployment are not exogenous events; they are the result of Fed actions _in response to_ exogenous events. The statement is, strictly speaking, tautology. What exogenous change would lead the Fed to execute (inter alia, by not raising the EFFR) said period?
Further Sahm says, “The pandemic upended those economic assumptions, and the Fed’s primary problem since has been high inflation.” Most probably. There have been both large economic shocks – COVID “lockdowns,” Putin’s invasion of Ukraine, the massive shift from consumption of services to durable goods -- and the large fiscal defcits, but Sahm does not say exactly what the assumptions had been that were that were upended. Nor does she explain why or what part of “high inflation” has been a problem and not just the response to these shocks.
Consequent to the lack of clarity of what the 2020 Framework was, the change, “Average inflation targeting and reacting to shortfalls (but not excesses) in employment will likely be removed” is equally unclear. Was the average inflation targeting that is to be removed backward or forward looking? But what does “The Committee reaffirms its judgment that inflation at the rate of 2 percent,” mean if it is not some kind of average?
Will shortfalls in unemployment no longer call for a response (no use of the full range of tools to increase in inflation), but excesses will?
And what is different about:
“The maximum level of employment … changes over time owing largely to nonmonetary factors that affect the structure and dynamics of the labor market. Consequently, it would not be appropriate to specify a fixed goal for employment”
Sahm’s exposition raises the right issues but they remain unresolved.
And so they shall remain until a subsequent Substack post. 😊
Image Prompt: Person at a lectern, blackboard in the background, explaining monetary policy.
[Standard bleg: Although my style is know-it-all-ism, I do not deny that I can be mistaken or overstate my points. I also know there is an amazing range of views and experiences among readers. Bring those to bear by commenting on these posts. Both other readers and I will benefit.]