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.