Should the Fed tighten?

by on August 30, 2015 at 12:14 am in Current Affairs, Economics | Permalink

1. I do not know what the Fed should do, and I do not know what the Fed will do.  I don’t even like that phrase “should the Fed tighten?,” but the superior “what kind of multi-dimensional expectational monetary path should the Fed indicate?” is awkward.

2. Starting in 2008, I thought money was too tight during 2007-2011, and in general I am not afraid of upping the dose of inflation, ngdp, however you wish to express it.  I have never had “tight money” in my blood, so to speak.

3. There is good evidence from vacancies and the like that labor markets are fairly tight right now, equities are high and apparently China-robust, and we just had a gdp report of 3.8%.  So something other than more monetary loosening ought not to be out of the question.  Those variables simply cannot be irrelevant for the Fed’s current choice.

4. There is not a stable Phillips curve.  So the lack of strong price inflation does not carry clear labor market implications, nor does it mean we can boost employment through looser money.

5. Often I buy the “asymmetry argument.”  That suggests more price inflation probably won’t hurt us much, but monetary tightening could damage labor markets, so why tighten?  Paul Krugman among others makes this argument.

6. Now the risks look fairly symmetric.  The first reason is that zero short rates for so long might be encouraging excess risk-taking in the financial sector.  This can be the “reach for yield” argument, which in spite of its lack of replicable econometric support commands a lot of loyalty from serious observers within the financial sector itself.

7. The second reason for symmetric risks is that zero short rates for so long might be encouraging zombie companies:

The end of ultra-low interest rates may bode ill for the productivity of British businesses, which is already poor. Output per hour is still lower than before the crisis of 2007, whereas in America and even France it has grown. Tight monetary policy should be bad for productivity, since it makes business investment more expensive. As the cost to businesses of borrowing has fallen by more than half since 2008, investment by firms has risen by 20%. The worry now is that dearer borrowing will curb the investment binge, making productivity even more dismal.

Yet there is another side to the productivity equation. Kristin Forbes, a member of the MPC, points out that, as in Japan in the 1990s, cheap borrowing may allow inefficient “zombie firms” to survive for longer than they normally would. In Britain interest payments as a share of profits have fallen from about 25% in 2009 to 10% today, bringing down company liquidations with them. As they stagger on, zombie firms hold down average productivity levels in their industry and, as a result, put a lid on wage growth. Rising interest rates could slowly start to sort the wheat from the chaff.

That is from from The Economist and of course you can adapt it for an American context.

8. Those two arguments might be meaningful with only a chance of say fifteen percent each, but that still would put the risks in a broadly symmetric position.  I don’t see that the critics have made the case that a mere quarter point rate increase should be so damaging.

9. The contrarian in me rebels when I see article after article, blog post after blog post, consider the monetary policy problem in only two dimensions, namely as would be expressed by a Phillips curve.  See #4.  The “nice view” of monetary policy, as Faust and Leeper suggest (pdf), is probably wrong.

10. If I were at the Fed, I would consider a “dare” quarter point increase just to show the world that zero short rates are not considered necessary for prosperity and stability.  Arguably that could lower the risk premium and boost confidence by signaling some private information from the Fed.  But it’s a risk too — what if the zero rates are necessary?

11. The prospect of a stronger dollar, and the subsequent hit on American exports, remains a domestic reason not to let rates rise.  I doubt if it is a global Benthamite reason, but it is probably a reason held by some within the Fed.

12. The biggest piece of information here is that both Janet Yellen and Stanley Fischer both seem genuinely uncertain as to what the Fed should do.  No, they haven’t been absorbed by the hard money Borg.  They have their own version of these arguments and it seems they see the risks as being relatively symmetric, and thus the correct monetary policy choice is far from obvious.  No one has yet said anything that is smarter or more potent in Bayesian terms than what they probably are thinking.

13. Let’s say the Fed did decide to allow rates to rise.  How exactly would they make that happen?  How hard would it prove to accomplish?  That’s an under-discussed angle to all of this.  And the Fed might either wish to postpone this curiosity or get it over with, another set of symmetric risks.

We’ll know more soon.

1 Brian Donohue August 30, 2015 at 12:50 am

Good post, but to me the burden of proof is on those who want to raise rates.

Labor market tightness? Not so much. Each month of 200,000+ new jobs includes a slug of people some thought would never be coming back.

CPI? Nothing to report.

Asset bubble? S&P 500 P/E ratio 16.8.

Real estate? Good one.

Let the long, slow recovery continue, Janet!

Having said all that, I don’t see a quarter point as a huge deal, but (re #13) it will push long- term yields down, leaving little scope for additional increases anyway.

2 dearieme August 30, 2015 at 6:04 am

the superior “what kind of multi-dimensional expectational monetary path should the Fed indicate?” : well, that certainly provoked a guffaw. A multidimensional path, eh?

3 Adrian Ratnapala August 30, 2015 at 7:23 am

Path through a multidimensional space. If tight-vs.-loose were the the only axis, there would only be one dimension.

4 dearieme August 30, 2015 at 11:21 am

Ah, so it would have sounded better in his mother tongue? Because in English it’s twaddle.

5 joe August 30, 2015 at 7:32 am

200,000 is now the monthly rise in U.S. population, so that is no indication of people going back to work

6 Brian Donohue August 30, 2015 at 7:40 am

The natural growth of the labor force is way under 2.4 million per year.

7 Joe August 30, 2015 at 7:59 am

I’d need to see some data to back that up. The histogram of US population by age group is very flat, so that would indicate to me that the percentage of people of working age has been rising steadily with the population as some age into it and others immigrate into it. I’m not even sure job growth has kept up with the rise in working age population.

8 JWatts August 31, 2015 at 11:17 am

US population growth as been between 0.7 and 1.4% for 50 years. Current population is around 315 million. So normal population growth is in the 2.2 to 4.4 million range.

9 Brian Donohue August 31, 2015 at 12:19 pm

@JWatts, The US has basically never added more than 2 million jobs per year over any extended period of time. Between July 1980 and July 2000, the economy added an average of 2.114 million jobs per year. That is the largest average increase over any 20 year period in this nation’s history.

For the past two years, the economy has added close to 3 million jobs per year. Lots of these people are “coming back” into the workforce, every month. That was my point.

Remember, people retire too. Lots of Boomers right now.

10 Cliff August 30, 2015 at 10:44 am

Terrible post imo. The only thing the Fed will be signaling if they tighten is that they are clueless morons and no one can know what their goal is. If their goal is 2% inflation then we have market expectations as far as the eye can see that inflation will not reach 2% pretty much ever. So that implies they should be loosening. If they tighten doesn’t that mean they have gone rogue and are operating without any principle?

11 mulp August 30, 2015 at 5:01 pm

How about they are indicating that government should not be distorting the market and they should exit trying to control the economy?

And go back to being the lender of last resort to protect savers by ironically preventing savers from converting savings to cash by making it possible for savers to convert deposits to cash in cases of mass hysteria, the reason the Fed was created, and also as a neutral intermediary between banks on asset pooling for risk sharing, ie recreating the US National bank Jackonites killed, and as the new sheriff after Congress preempted State law regulating debt instruments, but with Congress refusing to write the actual laws to replace the State laws as the back and forth between Phil Gramm and his wife and people who believe in rule of law applying to everyone, not one law for corporations and different laws for individuals. (Of course corporations can use Constitutional wealth redistribution to take the wealth from individual savers after the corporations squandered it, but no way does the Constitution intend for individuals to be able to declare bankruptcy to escape involuntary servitude for life, seems to be the principle of the Gramm camp. cf Trump serial corporate bankruptcy filer.)

I also remember the days when conservatives like Milton Friedman promised higher interest on savings than the 4-5% rate that was the maximum rate allowed and lower interest on personal debt than the 12% maximum both under Regulation Q. Why not try restoring Fed rates to the rates of the 60s? See if interest rates on savings will go back to 5%… 😉

12 Cliff August 31, 2015 at 1:26 am

I can’t say I understand what you are talking about, but the Fed doesn’t have any choice when it comes to controlling the money supply. They do control it, there is no way they can not control it even if they wanted to.

13 John August 31, 2015 at 10:29 am

Schiller PE, Tobin Q, and market cap/gdp all are very elevated. In fact they are levels only seen higher in 1929, 1999, and 2007. Real estate prices are through the roof in most major cities. This is a major asset bubble. The Fed certainly does not want to enter an asset bubble crash with zero percent interest rates, but that is precisely where they are headed.

14 Rock Lobster August 30, 2015 at 12:56 am

On the reach for yield, without going into too much detail, this is something I observe anecdotally in the bond market although I realize it “shouldn’t” be the case. The question of “what kind of yield should we target?” is not answered in a forward-looking context given the yield curve and corporate bond spreads. Rather, it boils down to, “OK what’s the average book yield of all the paper we have maturing this year, stuff that we bought 5-10 years ago? That’s what we want to replace.” Naturally everything that was bought in ’08-’09 is pumping out a nice fat coupon, but as it starts to roll off, you’re just not going to be able to replace, say, a 7% yield on a 10-year without skimping on the credit quality by a good amount.

The zombie company question is interesting to me. The way I look at it, a company is really only a zombie company with respect to a prevailing interest rate. If a company were to fail but for the interest-free loans being extended by the government, then you’ve got yourself a zombie company, sure. But if economic conditions call for a low benchmark interest rate across the board (with an inflation target or a Taylor rule or what have you), then I don’t think it makes sense to damn a company for operating with a lower threshold cost of capital. The only way I could see that working would be an Austrian type story where firms get lazy in the low-rate environment and then can’t cut it in the higher-rate one. But I don’t see that.

15 Yoav August 31, 2015 at 2:03 am

If you want to retire, you need or enough savings or enough return.
If the returns are low, you can’t retire.

16 TallDave August 30, 2015 at 1:10 am

Ha, I remember when 3.8% was considered just okay.

7. Why would zombie companies get cheap financing? Would you lend money cheaply to a company you expected to go out of business soon? Are there a large group of people (outside of government) who would?

No one really knows for sure to what extent monetary policy is superneutral in the short and long term, but the markets’ response to momentary loosening has been to see more growth, the markets’ response to tightening has been to see less growth. The markets might be wrong, but why would we assume that?

Oh and why does a quarter-point matter so much? Because the markets must extrapolate future Fed policy from small inflections, and the markets really care about the future path of monetary policy right now. Why?

17 Larry Siegel August 30, 2015 at 1:36 am

Actually, 3.8% in a period of near-zero population growth is pretty good. The labor market may be full of discouraged workers, but most of them aren’t coming back at any interest rate; their skills are worth less than the social safety net income.

In other words, the economy is close to normal. The normal, historical real interest rate is close to 2% so the Fed should announce its intention to raise interest rates to 2% over a relatively short period, starting with a 0.5% increase now. Note that I’ve assumed real=nominal i.e. 0% inflation. The case can be made for a nominal interest rate higher than 2% if inflation is higher than 0%, but let’s start with 2%.

Phooey on financial repression. It’s an unlegislated tax amounting to at least $500 billion a year.

18 joe August 30, 2015 at 7:41 am

We are not in an era of zero population growth at all. U.S. population is growing at 2.5 million per year.

19 Larry Siegel August 30, 2015 at 2:38 pm

Divide by the total population and you’ll see that is only 65 basis points a year. It’s not zero, but it’s *way* down from historical averages used to calculate long-term GDP growth rates.

20 Cliff August 30, 2015 at 10:46 am

Really, one quarter of decent GDP growth means we’re back to normal and we can shock the economy with an unexpected 2% rate increase even though inflation expectations are like 1.5% over 30 years?

21 Larry Siegel August 30, 2015 at 2:36 pm

We would be shocking the economy with a $500 billion a year increase in incomes received by savers. You must be an Old Keynesian.

22 Cliff August 31, 2015 at 1:27 am

Uh, okay. And what direction do you think the stock market would go? Shocking the economy with trillions in stock market losses as investors anticipate a downturn in the economy- but I guess you know better than the market?

23 Harun August 30, 2015 at 1:08 pm

“their skills are worth less than the social safety net income.”

plus the value they put on having a lot of leisure time.

24 TallDave August 30, 2015 at 3:34 pm

There is no “normal” interest rate, there are only market rates. Rates were in the high teens in the early 1980s, but inflation expectations are much lower today.

A 2% hike would be deeply contractionary, an unlegislated tax destroying trillions in wealth.

25 Phil H August 30, 2015 at 2:03 am

Yeah, that Economist argument makes no sense at all. The pressure that drives bad companies out of business is supposed to be competition from better companies, not pressure from the banks. If Britain (or America) is so lacking in innovation that no-one can set up new competitors to take out zombie companies, then changing interest rates isn’t going to make any difference.
Logic fail.

26 Art Deco August 30, 2015 at 11:39 pm

You are under the impression that it was uncommon prior to 2008 to go out of business for want of credit? Or that creditworthiness is not an indicator of a going concern?

27 Sam Brasel September 5, 2015 at 11:10 am

First, pressure from competition. Then, due to inability to weather the competition, pressure from the banks. Where is the evidence that low interest rates have made industry competition-free / bad-credit-free? Cowen is just grasping at straws with this ridiculous argument. He starts with the conclusion that his wealthy clients don’t like the current Fed rates and works backwards from there.

28 JVM August 30, 2015 at 1:34 am

10 year TIPS at 1.58%, far greater than the historic average of >2%, I think the burden of proof is on anyone who would choose not to loosen at this point.

https://research.stlouisfed.org/fred2/series/T10YIE

In my mind the purpose of monetary policy is to ensure that nominal contracts are predictable. If I sign a contract with Scott Sumner to give him $100 in 2025, under perfect inflation targeting I know the CPI value I have promised him, and under perfect NGDP targeting I know the % of output I have promised him. Unexpected loosening moves contracts in the favor of debtors, and unexpected tightening moves contracts in favor of creditors. Both decrease the efficiency of contract making; the latter is particularly dangerous because it increases default rates. Under the above point of view, raising interest rates when NGDP and inflation are below trend isn’t intrinsically very damaging, it’s damaging because it sends the message to the markets that the FOMC has no idea what it’s doing. But perhaps the cat is already out of the bag on that one.

Tyler, if you think this view of monetary policy is insufficiently nuanced I’d love to hear a critique!

29 Larry Siegel August 30, 2015 at 1:40 am

The 10-year TIPS is at 0.58%. Neither 0.58% nor 1.58% is more than 2%.

30 JVM August 30, 2015 at 12:48 pm

Yup, sorry about that, I meant TIPS spread (not TIPS itself) and I miswrote ‘greater than’ when I meant to write ‘below’, the rest of the comment was based on that interpretation.

31 JVM August 30, 2015 at 12:47 pm

CORRECTION: I meant far **below** the historic average.

32 JVM August 30, 2015 at 12:49 pm

CORRECTION 2: I meant TIPS spread, not TIPS.

33 TallDave August 30, 2015 at 3:23 pm

Yes. Inflation targeting should not give way to a regime of trying to get back to “normal” interest rates, that makes even less sense.

Meanwhile, the Fed is reporting that the market is predicting the Fed will decide to miss the Fed’s inflation target. You couldn’t make this up, too bizarre to be plausible.

34 carlospln August 30, 2015 at 1:42 am

“Despite 58 consecutive months of rising payrolls, 8.3 million workers were looking for a job but couldn’t find one in July, while others had given up looking or were stuck in part-time jobs but would have preferred a full-time position” SOURCE: WSJ link

“The Labour markets are tight right now”

Laughable.

35 Apeman August 30, 2015 at 9:10 am

You have not tried to hire anyone recently if you think it is laughable.

I might know some of those who 8.3 million looking for jobs but “can’t find them.” I know a just graduated mechanical engineer who wants a job in particular area near home in upstate new york who has yet to find a job in spite of graduating in the spring of this year. Is that proof of a labor market that is not tight? I know people with drug problems (one was let go where I work for that reason. We don’t drug test, but we do require you to act safe and stay upright) that are having problems keeping jobs. Is that proof that the labor market is not tight?

In a nation of 300 million people, there is always going be a number of people who are effectively worthless or have unrealistic expectations that keep them from “settling”. The fact that there are people who have a degree in communications who are working part time at Starbucks while they look for a “job” does not change the fact that a kid with a GED who went to trade school at night part time for 6 months and has no other work experience can be hired by a company whose welding test he failed for $15 an hour plus 10 hours of overtime a week because said company is so desperate for welders they will take anyone with a clean drug test and a basic idea of what welding is about. (I don’t know how it is in other parts of the country, but $15 an hour is a good entry wage for around here, experienced welders make a lot more than that).

In short, for every “underemployed” person I know, I can name 10 crappy people who were hired because it is hard to find good people to fill jobs. Now my anecdotal observations and personal experience trying to hire are next to worthless. The only thing more worthless is the idea that 8.3 million looking for work in a nation of 300 million is proof that the labor market is not tight.

36 chairman August 30, 2015 at 12:24 pm

I don’t believe it for a second. There are how many hundreds of applicants for every open job? The only way to find a job that pays anything decent is to have a very specific technical skill right now. If companies were having a hard time finding people to work for them they would offer to train them, but no company does this. No company in the entire country has any problem finding someone competent enough to fill any job position they have open, as long as they’re paying more than, say, 12 dollars an hour.

37 Cliff August 30, 2015 at 1:10 pm

This is not even remotely true.

38 Harun August 30, 2015 at 1:15 pm

When companies agree to hire communications majors and train them on company dime to be welders, then we can say its a tight market.

Its weird that its been welder-welder-welder for years now. Are the welding programs not turning out enough people? Are we suddenly demanding more welded products? Is the relentless focus on feeding academia, excuse me, encouraging kids to go to college meaning no kids go to welding classes?

Also, does Mexico not produce any welders? Are there no H1B1 welder visas?

39 Cliff August 30, 2015 at 2:34 pm

Plenty of trades pay high incomes. I doubt many communications majors are volunteering to learn how to weld. Otherwise they might have done that in the first place.

40 chairman August 30, 2015 at 3:53 pm

If a company located in a reasonably populated metropolitan area offered, say, 12 dollars an hour paid training to learn welding leading to a 15/hr starting job, they would have more capable people applying than they could possibly hire.

41 Cliff August 31, 2015 at 1:29 am

I imagine there are plenty of people doing just that. How much does it pay to be a plumber’s apprentice? And a master plumber makes great money.

42 Jeffrey Deutsch August 31, 2015 at 10:36 pm

Check out Peter Cappelli’s _Why Good People Can’t Get Jobs_ for an intriguing look at the training and employment situation in America now.

43 derek August 30, 2015 at 1:43 am

Keep interest rates extremely low and price labor at $15 per hour! Everyone needs a good long holiday anyways.

They won’t raise rates. Government debt costs are a real issue, and the only purpose of the Fed is to keep the government solvent. This is the Keynesian end point where capital costs almost nothing. Keynesian ideals don’t whither away or get nibbled at a quarter percent at a time. They fail dramatically, unexpectedly and suddenly. Until then the mesmerizing attractiveness prevents any contrary action.

44 ChrisA August 30, 2015 at 2:28 am

I just don’t understand why we are having this debate. Raising and lower interest rates is about keeping inflation on target. But every indicator that you can find is saying that it will be below the target for a long time. So why on earth is there a discussion about raising rates? Just because a decade or so ago rates were higher? That is as about a weak argument as can be found.

Some stupid decisions were made by policy makers during that 2008 crisis, when they simply ignored basic well understood monetary policy. Do we really have to go through this again.

45 Kevin Erdmann August 30, 2015 at 3:27 am

+1

46 Harun August 30, 2015 at 1:17 pm

I hadn’t looked at inflation rates for a while until last week someone told me they were at historic lows, and boy we’re they correct! It seems strange to want to raise rates in such an environment.

47 js August 31, 2015 at 12:56 am

I think Tyler obviously doesnt state explicitly but his underlying motivation is to deal a mortal blow to China even though it will destroy some other EM economies and hurt US as well. Given China’s current fragile status this could would trigger a collapse. Would teach them a proper lesson. What with all that Treasury bond selling and currency devaluation.

48 Shaun August 30, 2015 at 2:28 am

To what degree do the monthly wage growth figures take into account variable pay?

49 Kevin Erdmann August 30, 2015 at 3:26 am

1) Not only is inflation low (1.7% core CPI and 1.2% 5 year TIPS spread), but most of that is from shelter. Take shelter inflation out of core CPI and it is below 1%. Since housing starts are just now reaching what would have previously been considered deeply recessionary levels, after nearly a decade of being below those levels, this is clearly supply-side inflation, not demand-side inflation. Since there is no reason to expect the housing problem to be solved soon (rent inflation has been high for 20 years), those forward TIPS spreads are likely anticipating “Core minus shelter” inflation below 1%. Tightening would be crazy. The only question would be whether a rate hike would be similar to the August 07 error or the September 08 error. On the bright side, since the mortgage market is dead already, the Fed can’t kill it twice.

2) Low interest rates are decidedly not associated with rising corporate debt. I believe corporate debt in Japan has generally declined since the late 1980s. Corporate debt in the US also was much higher in the 1970s & 1980s, as counterintuitive as that is. Corporate debt levels have declined significantly since the crisis, relative to equity values, and are basically at the lowest levels on record. The notion that low interest rates are dangerous because they lead to corporate overleverage is one of those ideas that seems to obvious to confirm, so it is widely cited, despite being wholly at odds with the data. In terms of interest rates and risk premiums, corporations are price takers. Leverage is low for the same reason that interest rates are low. It’s kind of like reasoning from a price change, except on this topic, it’s more like assuming data from a price change.

https://research.stlouisfed.org/fred2/graph/?g=1IM6

50 js August 31, 2015 at 12:59 am

I think Tyler obviously doesnt state explicitly but his underlying motivation is to deal a mortal blow to China through a rate hike! Even though it will destroy some other EM economies and hurt US as well. Given China’s current fragile status this could/ would trigger a collapse. Would teach them a proper lesson. What with all that Treasury bond selling and RMB currency devaluation. Maybe China might retaliate but then currently ruining the other might seem more lucrative than saving oneself. #NuclearOption

51 TallDave August 31, 2015 at 3:25 pm

Great points.

52 Market Timer August 30, 2015 at 3:39 am

Raising interest rates will raise inflation. The Fed is not talking about selling bonds to reduce the money supply. They are going to increase the interest rate they pay to banks on excess reserves, which will increase the money supply. John Cochrane has a good article on this.

53 Kevin Erdmann August 30, 2015 at 4:58 am

If raising rates would be associated with selling bonds, then raising interest on reserves should have the same effect. A bank sending more reserves to the Fed is basically the same as buying a bond from them. Isn’t higher ior going to result in some conversion of currency into reserves?

54 Market Timer August 30, 2015 at 5:42 am

The two mechanisms are very different, even if we suppose that the cash banks voluntarily hold on reserve at the Fed is effectively the same as cash the Fed has withdrawn from banks. If the Fed sells bonds to raise rates, that necessarily removes cash from banks. If the Fed increases interest on excess reserves, that does not necessarily increase the quantity of reserves supplied by banks. Excess reserves are more a function of credit spreads than the absolute level of rates. And the movement in credit spreads is second order to the move in nominal rates. Typically, the increase in interest rates gets passed on directly to the borrower. For example, when Fed Funds increases by 1%, the Prime rate will also increase by 1%.

I think the Fed cannot do much to change the real interest rate, but has a great deal of control over nominal rates (and hence inflation). Paying higher nominal rates should lead to higher inflation.

55 TallDave August 31, 2015 at 3:32 pm

If the Fed increases interest on excess reserves, that does not necessarily increase the quantity of reserves supplied by banks. Not necessarily, no, but very likely.

Paying higher nominal rates should lead to higher inflation. Empirically this clearly does not happen, but it might be worth considering why. Suppose tomorrow the Fed targets a Fed Funds rate of 10%. Now remember, the Fed does not set the rate! They engage in OMO to push the rate where they want it. So, how does the Fed accomplish this? Is the action taken to accomplish this massively expansionary, or massively contractionary? 🙂

56 TallDave August 31, 2015 at 3:37 pm

Although I should note there is counterintuitive way the Fed could arrive at a ~10% Fed Funds rate: promise to target inflation at >10%.

Eventually the Fed Funds rate would rise on the back of inflation expectations.

If it seems hard to believe inflation expectations could drive the Fed Funds rate into double digits, well, it’s what actually happened in the 1970s.

http://awealthofcommonsense.com/wp-content/uploads/2014/12/Fed-Funds.png

57 Art Deco August 30, 2015 at 7:39 am

They are going to increase the interest rate they pay to banks on excess reserves, which will increase the money supply.

Hardly. The interest paid on reserves dramatically reduced the money multiplier.

58 er August 30, 2015 at 6:14 am

should is different than will, you’ve muddled them!

59 rayward August 30, 2015 at 6:55 am

Cowen is a two-handed economist! A rare bird today. In a time long ago economists of all political persuasions were often derisively referred to as two-handed (“on the one hand, . . .”), the implication being that the two-handed economist didn’t know what she was talking about, or even if she did wouldn’t take one side or the other for fear of being wrong. Far from lacking knowledge, the two-handed economist understood both sides very well and also knew that economics is not an exact science. With today’s tribalism few economists have the self-confidence to express both sides for fear that their tribe will reject them as disloyal. How did the economics profession fall so far so fast. Cowen, on the other hand, has the self-confidence to be two-handed.

60 Greg G August 30, 2015 at 7:22 am

Good point rayward. I attribute it to Tyler’s time as a serious chess player. No one gets very far in chess without considering the possibility that their opponent might be seeing something they are not seeing.

61 BayRidge August 30, 2015 at 9:33 am

## “…a two-handed economist! A rare bird today.”

Indeed “2-handed” is the professional standard, as President Truman woefully noted two generations ago.

That “Janet Yellen and Stanley Fischer both seem genuinely uncertain as to what the Fed should do” confirms the norm for highly credentialed economists.

Would you be concerned if the pilots of your airliner seemed uncertain how to navigate and land the aircraft?

Perhaps national monetary policy and dictates are all a tragic charade by pompous poseurs.

62 Larry Siegel August 30, 2015 at 2:43 pm

The economy is not an aircraft (channeling the great cartoon presentation of Hayek: “the economy is not a car”) and economics is a social science, not an exact science. Economists had better be two-handed.

63 Sam Brasel September 5, 2015 at 11:17 am

In this case, Ray, what Cowen is doing is presenting a policy prescription that he knows makes no sense. So he has to go the two-handed route in the desperate hope that doing so will make his post pass the laugh test with at least a few readers.

“If I were at the Fed, I would consider a ‘dare’ quarter point increase just to show the world….” Hahahahaha! Oops, I guess it didn’t pass the laugh test with me.

64 Mark Cancellieri August 30, 2015 at 7:21 am

Are there any examples where ZIRP actually worked and countries began to grow rapidly enough that they raised rates?

65 Ted Craig August 30, 2015 at 8:46 am

There is actually evidence that monetary policy is an effective tool for inflation, but does little to combat deflation. Fiscal policy is a better cure, but that’s not going to happen in our current political climate.

66 Mark Cancellieri August 30, 2015 at 9:12 am

I disagree that fiscal policy is a better cure. There is little evidence of it.

67 Art Deco August 30, 2015 at 10:08 am

The ‘evidence’ is all in your head. The Federal Reserve managed to cure deflation fairly rapidly in 1932-33 with open market operations and a devaluation of the dollar. No amount of public works spending has helped Japan (whose public debt now stands at 200% of gdp).

68 Ted Craig August 30, 2015 at 10:32 am

A small amount of public spending in Japan did very little:

http://www.petersoninstitute.org/publications/chapters_preview/35/2iie2628.pdf

69 E. Harding August 30, 2015 at 2:16 pm

Which is why Japanese gov’t debt is totally not 200%+ of GDP.

70 Brian Donohue August 30, 2015 at 4:56 pm

Six years into the recovery, and the federal deficit this year is still $500 billion.

We have been ‘doing fiscal policy’ at an impressive clip all century.

71 Ted Craig August 30, 2015 at 5:37 pm

No, we haven’t:

http://money.cnn.com/2014/01/27/news/economy/spending-obama/index.html

You guys are really hung up on deficits when you should be looking at actual numbers.

72 Brian Donohue August 30, 2015 at 6:02 pm

Ted,

Your link is 19 months old. In the past year, the deficit was INCREASED from about $400 billion to $500 billion, as the economic recovery has proceeded. The Keynesian fairy tale suggests this should be moving in the other direction at this point in the economic cycle.

73 Cooper August 30, 2015 at 9:48 pm

From FY2011 to FY2014, the budget deficit shrank from $1.3 trillion to under $500 billion.

That should have caused an economic collapse, deflation, rising unemployment, etc. It didn’t.

The UK has pursued steady budget reductions while unemployment growth has stayed strong.

The New-Keynesian story is just as broken as the Austrian “QE=Hyperinflation” story.

74 Brian Donohue August 30, 2015 at 10:43 pm

@Cooper, well yes, Keynesians (those who think at 0% interest rates monetary policy is pushing on a strong, as well as those who imagine some kind of Wall Street film flam) along with the ever-suspicious Austrians, are a constant threat to monetary sanity.

Every day, I appreciate more what Friedman was up against.

My point here is that, in the past year, we have seen $100 billion in ‘fiscal accommodation’ in the form of an increase in the deficit during a fairly mature point in the economic recovery, but the Keynesian ‘more, more more’ drumbeat goes on as ever.

75 Greg August 31, 2015 at 9:02 pm

You mean that less than 2.7% of GDP deficit? http://www.businessinsider.com/federal-deficit-will-be-lowest-since-2007-2015-7

Seems pretty weak for “doing fiscal policy” to me.

76 Brian Donohue August 31, 2015 at 9:39 pm

Classic. A Keynesian caught in his natural habitat: spending money he has no intention of paying back, ever.

When they want to be taken seriously, they talk about deficit spending during recessions.

In reality, though, a 2.7% of GDP deficit in year six of an economic recovery doesn’t satisfy the real, much simpler, modus operandi of “more, more, more”.

Thank you for removing the mask.

I would laugh, but there’s this thing. I call it the Baby Boom Entitlement Tsunami. It’s coming in just a few years. And there will be no money for fun new government stuff. Miserable times for government. This is not an economic forecast. It’s a demographic reality barrelling at us.

And we will wonder why we spent the first 15 (20?) years of the 21st century engaged in stupefying public sector finance profligacy.

77 rayward August 30, 2015 at 7:22 am

There are consequences to being wrong as an economist, just as there are consequences to being wrong as a member of the tribe. Which is worse? Arguably being wrong as an economist doesn’t come at nearly as high a cost as being wrong as a member of the tribe. In that context, I’ll add to Cowen’s two-handed list: one the one hand, if raising rates causes asset prices to fall, and fall, and fall, does the Fed have the tools left in its box to manage (manage being all that we can expect) the fall; on the other hand, if not raising rates causes asset prices to reach a bubble level (which, according to Shiller, may have already occurred) and the bubble bursts, does the Fed have the tools left in its box to manage (manage being all that we can expect) another financial crisis.

78 meets August 30, 2015 at 7:24 am

I liked Lars Christensen’s take.

The FED has essentially been tightening already, hence the strong dollar. And no one was afraid of the rate increase in September until the China demand shock.

Sure, we have weathered the China problems well, but that doesn’t mean a short postponement in a newly “tight” environment isn’t appropriate.

http://marketmonetarist.com/2015/08/24/the-dollar-bloc-was-never-an-optimal-currency-area-and-now-it-is-falling-apart/

79 Walter August 30, 2015 at 8:01 am

I just want inflation to eat away my mortgage then we can go back to zero.

80 A Definite Beta Guy August 30, 2015 at 8:44 am

I want an ultra-tight employment market so I can tell my employers to fuck themselves.

“You’re not working 66 hours over the next 3 days? Jesus, it’s like talking to a brick wall! You need to do this!”

81 Mark Cancellieri August 30, 2015 at 8:25 am

I think that it is a mistake to focus solely on consumer prices and ignore the inflation of asset prices as irrelevant. Why is it a positive when consumer goods are cheap, but it is a positive when assets are expensive? This seems to imply that consumption is more important than investment to long-term growth.

82 ladderff August 30, 2015 at 11:34 am

Thank you. This whole discussion is 1) retarded and 2) based on the bad idea that the point of the economy is to keep people working, rather than to get them the things they want. I love this constant shouting of THERE IS NO INFLATION SO KEEP THE PRESSES RUNNING when everything a normal family actually pays for has gotten drastically more expensive in the past few decades.

83 radical_centrist August 30, 2015 at 12:10 pm

agreed, and also ZIRP steals from senior citizens.

84 Cliff August 30, 2015 at 2:38 pm

So you are saying that living standards have declined over the past few decades? I don’t think so. If everyone wants positional goods, it is logically impossible for everyone to obtain them and therefore pointless to have that as an objective.

85 ladderff August 30, 2015 at 4:02 pm

What I’m saying is printing up tons of money and keeping everyone (everyone who works I mean) chasing it like maniacs just so they can further bid up the price of positional goods is stupid (based on your comment it looks like you can see why), and we don’t actually have to do it. It’s good for certain people, but it’s not good for most people.

86 Brian Donohue August 30, 2015 at 5:09 pm

Drastically? Well, a measly 2% inflation over 30 years translates to an 81% increase in prices, so…yeah, I guess.

Inflation has averaged more than 2% since 1950. Are we poorer than 65 years ago?

87 ladderff August 30, 2015 at 6:17 pm

Are we poorer than 65 years ago? That’s the best you can do? You might have asked, are we poorer today than we need to be, especially given the available technology. You might ask whether the working population works longer weeks than it has to to achieve the same level of output. But that might leave certain people looking foolish.

88 Brian Donohue August 30, 2015 at 7:00 pm

Yeah. And hoverbikes!

Don’t give me no hand me down world.

I got one already.

89 Cliff August 30, 2015 at 2:37 pm

If you think it’s a mistake than you should lobby to change the Fed mandate. As long as the Fed mandate is 2% consumer price inflation, it is insane to tighten.

90 ladderff August 30, 2015 at 3:47 pm

Consumer price inflation is the wrong thing to look at.

91 Brian Donohue August 30, 2015 at 5:15 pm

What part of S&P 500 P/E ratio of 16.8 don’t you understand?

92 Cooper August 30, 2015 at 9:53 pm

Brian Donohue,

Just to play the devil’s advocate here, the Shiller PE ratio is 25. That’s about where it was during the 2000s housing bubble and is above the historical norms.

http://www.multpl.com/shiller-pe/

93 Brian Donohue August 30, 2015 at 10:36 pm

Shiller’s 10 year average is a horrible idea here.

Sometime in 2019, when the 2008-2009 earnings years fall out of the equation, it will suddenly look bullish.

94 meets August 30, 2015 at 8:28 am

The FED has been tightening with hawkish statements all year.

No need to “prove” anything with a rate raise.

95 Horhe August 30, 2015 at 10:01 am

Such a naughty title question! Well, there are exercises the Fed can do, and also some surgeries.

96 Cowboydroid August 30, 2015 at 10:19 am

“11. The prospect of a stronger dollar, and the subsequent hit on American exports, remains a domestic reason not to let rates rise.”

As an economist, you should be above making this silly error, Tyler.

97 Yancey Ward August 30, 2015 at 10:39 am

Shorter Tyler:

“As an economist, I don’t have a fucking clue.”

98 Ray Lopez August 30, 2015 at 10:49 am

But TC is honest. Since money is neutral (TC is a closet Fisher Black fan, who thought likewise) then indeed what the Fed does is irrelevant. And no less than Ben S. Bernanke, before he became Fed chair, thought likewise*.

* Measuring the Effects of Monetary Policy: A Factor-Augmented Vector Autoregressive (FAVAR) Approach * Ben S. Bernanke et al (2003) Apart from the interest rates and the exchange rate, the contribution of the policy shock is between 3.2% and 13.2%. This suggests a relatively small but still non-trivial effect of the monetary policy shock. In particular, the policy shock explains 13.2%, 12.9% and 12.6% of capacity utilization, new orders and unemployment respectively, and 7.6% of industrial production

99 Cliff August 30, 2015 at 1:12 pm

“Relatively small but still non-trivial” and that’s on the real economy

100 Brian Donohue August 30, 2015 at 5:13 pm

Nice. The Ray-bot has been barfing up that passage for a couple weeks now.

101 Patrick MacAuley August 30, 2015 at 11:07 am

“11. The prospect of a stronger dollar, and the subsequent hit on American exports, … is probably a reason held by some within the Fed ” [as a reason to delay tightening].

These global effects are surely among the Fed’s main considerations right now. The unpleasant hit on American exports would be less important than the further inroads by imports to America. And the financial flows, which would be much larger than the trade flows in the short run, would suck “hot money” from weaker economies to the US. Global integration has advanced so far that Fed policies need to be coordinated with other Central Banks. With the EU, China, Japan, and others engaged in looser monetary policies, the Fed is in a tricky position right now.

102 Tom Warner August 30, 2015 at 11:36 am

My impression is that Fischer is the main driving force for a rate hike. That may be an exaggeration but I just don’t hear anyone else on the board forcefully pushing alternate views. He seems confident inflation will rise as the high comparison base for raw materials fades into the past, and he seems willing to use more dollar appreciation to absorb it. I think the NYT misunderstands Fischer calling him an inflation “optimist.” He seems wary of unanchoring of long-term expectations, as Bernanke warned about when rejecting a higher than 2% target.

As to how a hike could hurt the rest of the world, be clear on what the problems are: high dollar debts in many countries, and the traditional upwardly-biased creeping dollar peg in China, which means that China has to choose between losing competitiveness against Asia and Europe or disrupting its capital markets due to dollar-referenced savings mentalities. My sense is there’s nobody on the Fed pushing to accommodate any of that. After all EMs with low dollar debts and a US orientation benefit from appreciation by selling more to the US.

I don’t know what econometrics you’re seeing, but the reach for yield is obvious throughout the US economy, especially in urban residential inflation. We’re seeing a lot of traditional family landlords cashing out as institutional financial investors with lower yield tolerance pile in. In NYC there’s an epidemic of closed storefronts as institutional investors must utterly ruthlessly maximize rent to earn anything and many were sold unrealistic forecasts.

103 Ram August 30, 2015 at 12:08 pm

Tyler,

What do you think the Fed’s ultimate objective should be? What do you think it is in fact (like it or not)? Does it even have one, given irresolvable differences between its various voting members?

What measurable indicators can we use to determine whether the Fed is on track to achieve these objectives? What do these indicators presently indicate? Which instruments should the Fed use to move these indicators towards more favorable levels, and how should they be set in order to accomplish this? What are the consequences of mis-setting these instruments, and what are the consequences of setting them appropriately?

It seems to me that any case for “raising interest rates”, or not “raising interest rates”, has to lay out answers to each of these questions in order to make any sense. Alternatively, probability distributions over answers to these questions (or preference orderings for the normative items) would be welcome. Your posts on the topic vaguely indicate some ideas about each of these items, but if I am a policymaker, I need something concrete to work with to make a transparent decision. Even worse are the parades of op-eds directly assessing the interest rate question without even addressing any of these more fundamental issues. As Scott Sumner might say, everyone is telling the Fed how to manipulate the steering wheel, but not what destination to drive towards, nor the way in which such manipulations will in fact lead us there. We owe the Fed and ourselves full consideration of the underlying issues in play before we make judgments about the outcomes of incredibly complex decisions.

104 chuck martel August 30, 2015 at 12:55 pm

I guess in a phony economy based on debt whatever a central bank does has some effect on the life of the plebs. In the real world literally nothing the fed does has any influence on the growth of corn, when cows chew their cud, the amount of rain that falls, the number of fish in the sea or how many pancakes it takes to shingle a doghouse.

105 Cliff August 30, 2015 at 2:39 pm

I guess in a normal economy having financial transactions whatever a central bank does has some effect on life.

FTFY

106 Lord August 30, 2015 at 12:58 pm

One rate would not be that significant but it would establish the expectation of continued increases which would be and no one expects one and done.

107 Philo August 30, 2015 at 1:01 pm

“[Z]ero short rates for so long might be encouraging excess risk-taking in the financial sector . . . .” “Might be?” Do you have any evidence that there *is* excess risk-taking in the financial, or any other, sector?

Never reason from a price change or, indeed, a price *level*–here, the price of capital (the price of “waiting” or of “abstinence”; short-term interest rates). Perhaps short-term interest rates are low because people are extremely reluctant to take risks.

And how much control does the Fed have over short-term interest rates? It controls the Fed Funds rate; what else? Are rates low because of Fed action, or rather because people are generally quite pessimistic?

108 CC August 30, 2015 at 1:28 pm

After reading this I’ve come to the conclusion that there is pretty much no reason for the Fed to raise rates. Thanks Tyler.

109 APM August 30, 2015 at 2:40 pm

http://www.wsj.com/articles/feds-fischer-good-reason-to-think-u-s-inflation-will-move-higher-1440865560

“Given the apparent stability of inflation expectations, there is good reason to believe that inflation will move higher as the forces holding inflation down—oil prices and import prices, particularly—dissipate further,” Fed Vice Chairman Stanley Fischer said Saturday at the Federal Reserve Bank of Kansas City’s annual economic symposium.

My question is – Has it been proven that cost-push inflation is a valid concept ? In what way oil prices being down will DRIVE inflation (down or up) ?

110 Los Ranchos August 30, 2015 at 3:25 pm

Well at least it’s been decided once again in plain sight. Macroeconomics as any kind of science, hard or soft, is a first rate farce.

111 ladderff August 30, 2015 at 10:18 pm

Correct.

112 R Richard Schweitzer August 30, 2015 at 7:40 pm

Just quietly, tippy toesy, SELL ASSETS and clean up the balance sheet, suck up some fiat currency and create a little pressure for fiscal (not credit) ti9ghtening.

113 bill August 30, 2015 at 9:06 pm

A main argument for tightening is that it is more normal. But the most abnormal aspect of policy today is the 25 bps of interest on reserves. For 95 years, IOR was zero. Even when the prime rate was 20%, IOR was 0%. Get rid of IOR first. Then other decisions can follow. IOR is just a gift to banks. No one else gets 25bps over night.

114 jorod August 30, 2015 at 11:31 pm

Rates are artificially low. This increases speculation. As rates go up, margin calls ensue. This may squeeze speculators and lower stock prices somewhat. But the key is growth and low taxes. But that requires responsible government spending policies, something Washington has been unable to do for the last 12 years or so, and something the Fed cannot control. Its job is to provide liquidity in times of crisis, not control the economy. And not reward excessive risk taking by banks.

115 Cliff August 31, 2015 at 1:33 am

What’s artificial about it exactly?

116 jorod August 31, 2015 at 9:43 am

Paying interest on Reserves? Not artificial? Low rates reflect bureaucratic meddling, not market reality.

117 js August 31, 2015 at 1:00 am

I think Tyler obviously doesnt state explicitly but his underlying motivation is to deal a mortal blow to China through a rate hike! Even though it will destroy some other EM economies and hurt US as well. Given China’s current fragile status this could/ would trigger a collapse. Would teach them a proper lesson. What with all that Treasury bond selling and RMB currency devaluation. Maybe China might retaliate but then currently ruining the other might seem a more lucrative than saving oneself. #NuclearOption

118 Ashby August 31, 2015 at 8:54 am

Before the crash of 2008, I remember reading a lot about the carry trade. The U.S. had higher rates of interest and return on investments, so people would pull money from Japan and invest it over here. Has anything like that been going on between the US and China in the run up to China’s problems? Is there much cheap foreign money invested in China that is now fleeing?

119 V September 1, 2015 at 2:10 am

Tyler – why won’t the Fed gradually unwind QE, rather than raising short term rates?

Given the uncertainty around the effects of QE, surely selling off the accumulated stocks of long term bonds would have fewer adverse effects than raising rates? It would also allow the Fed to credibly signal when short term rates are likely to rise (i.e. when QE has been fully unwound).

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