My quick response on the Fed

I’ve been making my way to Toulouse and haven’t followed all of the details.  Scott Sumner has many good posts on the topic, and I would put it thus: the Fed probably decided to do the best it could within political constraints and a framework of more or less stable prices.  Which won’t do much good at all.  Keep in mind:

1. The median voter hates price inflation.  Don’t blame Bernanke.

2. Today price inflation will accelerate real wage erosion, or at least is perceived so, who wants to take credit for that?

3. Core CPI is already going up at a rate of two percent and 3.8 percent for the broader bundle, at least for the time being.  Voters don’t know or care what is embedded in the TIPS spread, etc.

4. Some of the “inflationists” ignored supply-side factors and bottlenecks and didn’t see this price pressure coming.  That has thrown their entire analysis into doubt, unjustly probably but nonetheless.  In any case it is no longer the simple story where Q goes up first and only later does P rise.

5. If Ron Suskind is to be believed, our President seems not to know the difference between TFP and per hour labor productivity; in his defense a lot of economists don’t quite get that either.

6. The GOPers now send Bernanke epistolary romances.

7. Some people on Twitter were taking about “striking down Old Ben and having him come back stronger,” but a) Obi-Wan plain, flat out died, b) Obi-Wan’s younger prodigy, Luke, was a failure who relied on his dad and wouldn’t at the key moment listen to Old Ben and stay on the Dagobah system to invest in additional human capital (instead he read Caplan on the signaling model), and c) they never even made the final three movies of the planned nine, so we don’t know how it turned out with the unwinding of the fiscal stimulus on the Ewok world.  People, next time get your facts straight!

Every now and then, you ought to conclude that what you see is what you get and that is because of the rules of the game.  When it comes to further monetary stimulus, I’m not sure there’s so much more to say.


Tyler, I didn't realize you were such a Star Wars nerd!


"Obi-Wan’s younger prodigy, Luke, was a failure who relied on his dad and wouldn’t at the key moment listen to Old Ben and stay on the Dagobah system to invest in additional human capital (instead he read Caplan on the signaling model)"

This is the best thing I will read all day.

But staying on the Dagobah system was clearly the wrong decision. Yoda and Ben's predictions didn't come true. Luke was correct to rescue his friends.

Everyone should know that the correct explanation is the Luke Side of the Force.

If you're a Force user and you die while Luke is watching, you get a magical ghost body. It explains everything.

It worked.

"Obi-Wan has taught you well"

"But you are not a Jedi Yet" ABD

I loled

For me I am at a loss of what they expect to stimulate. If the FED is telling us rates are going to be low for the next couple of years, why should I make a capital investment or buy a house today?

1.The median voter in addition to hating inflation also hates having a high unemployment rate. To the extent that a trade off occurs between the two it is unclear how passionately the median voter feels about one or the other. I think generally the median voters opinion of the fed (how much does this matter) will be tied to the way that they perceive the macroeconomic situation generally.

2.Sustained high unemployment would also lead to real wage erosion by limiting the negotiating power of workers.

I suspect a couple of things. These are of course conjecture, butthey are based on my limited knowledge of reality.

The median employed voter worries about staying employed then he/she worries about inflation. Most employed voters are, rightly or wrongly, not too worried about losing their job at any particular point, they are more worried about loss of purchasing power, thus they are mostly worried about lnflation.

Unemployment, and underemployment, is currently running between 10 and 15 percent, and the employed and retired are the most likely groups to vote, so...

The median voter is employed or retired, and since the retired voter mostly worries about loss of purchasing power, the median voter worries about inflation.

Also a lot of voters, though less every year, are old enough to remember stagflation. It is noticable that the vast majority of pundits calling for inflation weren't paying attention back then, or even alive, looking at you Yglesias.

I agree that normal people (present company excluded) don't to pay more fun stuff and they don't like having less money in their bank account (like from losing a job, overtime, no raise, etc.). Now what is more important right now. Well, I would look at the Michigan survey. Inflation even headline is not crazy high and yet sentiment is really, really low. It could be a lot of things, but I suspect that people are not too please about the state of the real economy (read: it's not about inflation right now) and government's ability/decision not to fix the problems. But it's true if our 'fixes' lead to 10 percent unemployment and 10 percent inflation then we've got a bigger mess. (Now that is too depressing for even me to contemplate.)

We've been calling for a recession by the end of the summer since April. For us, it's pure oil shock, and at this point, I think both the direction of our forecast and its timing is looking pretty good. To paraphase James Carville: "It's the oil, stupid."

If it is an oil shock, here's what we can expect pro forma:

- unemployment rises four percentage points (to 13%)
- budget deficit rises by 2% (to around 11%, excluding any separate Greek default effects)
- Dow falls to 8,500-9.600 in the May 2012-May 2013 period (let's call the trough at 9,100 for a year from now)

I suspect, the median voter, has a job. The "macroeconomic situation generally" is equivalent to the threat of that median voter losing his/er job. And that, I agree is a concern at the family dining table.

Here's a Hill poll on inflation, and here's a Gallup poll, and here's a Rasmussmen poll.

While all differ on the exact numbers, they agree in broad strokes. The median voter is highly worried about inflation. Democrats are worried less about inflation, but still quite a lot. Indpendents are virtually indistinguishable from Republicans in worrying a lot about inflation.

That means that the inflation/hard money bit from the GOP is not an appeal to the base. It's actually a reach to the center.

Worrying about inflation may be wrong-- and I think it is wrong, according to the data-- but it's an attempt to go after the median voter, not play to the base.

Studies on median voter predictions on inflation tell you one thing: they are not forward looking; consumers expectations are based on their PAST.

You can find one of the studies here:

"Consumer expectations regarding inflation are almost perfectly correlated (the correlation coefficient = 0.94) with actual inflation over the previous 12 months, but significantly less so with future inflation. And on the spending side, consumer sentiment is also much more correlated with the change in real spending that took place over the past 12 months (coef = 0.76) than over the coming 12 months (coef = 0.42). So for both inflation and spending, the consumer survey data tells us much more about the past than the future. Something that's important to keep in mind when trying to read the economic tea leaves. "

Whoh! Whoh! Whoh!

Luke didn't fail. He knew only Anakin could defeat the emperor, as the emperor knew only he and Luke together could defeat Vader.

"c) they never even made the final three movies of the planned nine, so we don’t know how it turned out with the unwinding of the fiscal stimulus on the Ewok world. People, next time get your facts straight!"

First of all the Ewoks were hard money wonks as evidenced by their reverence for C3-PO (aka golden-rod).

Secondly the stimulus wasn't unwound. Stimulus is the spending of money and as everyone knows you don't need to get something productive out of it for it to stimulate.

Also you linked to the wrong death star.

I see the Death Star is like having the FDIC show up at your door.

Having a metal space station hundreds of miles wide explode in your upper atmosphere and rain debris on your population would certainly qualify as not getting something productive out of the stimulus.

In fact, the Ewoks were probably rendered extinct within days of the end of Return of the Jedi:

Is that anything like a satellite in a decaying orbit?

Whoh! Whoh! Whoh!

"the Fed probably decided to do the best it could within political constraints"

The fed does not have political constraints. The fed is independent.

Well, maybe when Perry is elected they'll be independent again.

Would that be Rick "treat him pretty ugly" Perry? Rick "almost treasonous" Perry?

Yeah, the guy who said those things clearly has an overwhelming respect for the independent Fed.


Ron Paul just called to say "How 'bout now?"

Well, then he'll be the one appointing Fed governors. Over half the board right are Obama appointees (counting those that he renominated), and he has open spots that he hasn't pushed on.

Presumably Perry will appoint people who see monetary policy the way he does. If that's so wrong, then clearly people are wrong to pulll for any President to appoint people who see monetary policy the way they do. (Of course, all of us like to imagine that our own personal views are simply "Science.")

"Presumably Perry will appoint people who see monetary policy the way he does"

I shutter to think who that might be.

The Fed is independent within the government.
It is not independent of the government.

Like the Supreme Court, the Fed also reads election results.

Which is exactly the problem. Both the Supreme Court and the Fed should be policy invariant. The changing faces of the Court and the FRB will change slightly as elections sway power, but their core functions should be independent. The dual mandate puts the Fed in lockstep with the administration, contrary to sound policy.

Surely, one sends "romantic epistles" not "epistolary romances," which is a holistic back-and-forth thing.

Re inflation comment: In case you haven't noticed, commodity prices (oil, copper, etc. ) have been dropping like a stone. Good luck with the inflation on non-core going forward. As to agriculture, I never knew there was an Austrian weather cycle that explained that, or a Keynsian one for that matter, but weather dominates ag prices.

5. Indeed

Delightful post, Tyler, thanks for sharing!

As a non-economist who hasn't followed Suskind's book too closely, would someone care to elaborate on what Tyler means here? I *think* I understand the difference between TFP and per hour productivity, but how exactly does/did this misunderstanding impact Obama's thinking and decision making (if Suskind is to be believed, which no one should, 100%)?

First of all, notice he said per hour LABOR productivity. Don't overlook the word labor there. TFP is Total Factor Productivity.

A sort of tongue-in-cheek answer is that economists make up random production functions to describe production as a combination of labor and capital. On their own, capital and labor don't give you a production amount that matches the measured level of total production. TFP is therefore whatever number is needed to make the left and right hand sides of the equation balance out. It's the residual. It contains all of the effects not accounted for by the inputs (ie, labor and capital). It could be technological progress, efficiency, human capital, or, as in the case of agricultural production, something like weather. Or, maybe, it just corrects for the measurement error in the other things. Who can really say for sure what is encapsulated in this variable for "whatever number is needed to make the equation balance?"

Anyway, this variable for "whatever is left over that we can't really explain or measure very well, but we need so that our equations are balanced" is VERY IMPORTANT. Whatever this residual is, it's the random changes in it that are the "technological shocks" that drive the business cycle in the basic RBC macro models.

That is, your model ends up with a bit that you can't explain. And, if you randomly make this unexplained thing go up or down in value, you end up with fluctuations in your model in economic activity (consumption, investment, etc.) that have variances and correlations somewhat close in value to those observed in past macro data. That is, if you exogenously make the random up and down shocks to this residual large enough and persistent enough.

I'll leave it up to a true macro person to give you the more serious response. My answer ignores the last couple decades of research into it and I'm being a bit unfair. My gets you up to the early 1980's (give or take). Someone else can explain the research on TFP and macro modeling since then.

Interestingly, TFP would also say that if worker skills deteriorate over time, making that factor of production less efficient, then a jobs program would improve efficiency and TFP.

But, you won't hear that here.

I like the example of a lights-out mfg plant. What is labor productivity when there isn't any labor?

Now, if two such plants have the same output but one cost twice as much, the difference would show up in their TFP. You couldn't measure that difference with labor productivity, since there isn't any.

Bill -- I don't think anyone argues training can't improve the productivity of workers; many if not most successful companies encourage training for that very reason. There is some question whether it is an appropriate and efficient use of taxpayer dollars -- that's exactly the philosophy that has led to massive subsidization and tuition inflation at all levels of education, with little to show in the way of results.

I expect most of the folks who read this site accept the limits of the knowledge problem. If that's the case, then how could anyone agree with the idea that the Fed needs to engineer "a little more inflation". Understand this, it may in fact be a good "school solution", but the ability to achieve that goal is beyond their capabilities. Granted, most politicians and probably some government economists think that the government (the Fed and the feds) can adjust the economy as if there were some magical rheostat in Washington. But, I think that all the macro tools at hand have more in common with blunt instruments than scalpels. The idea that the smartest guys in the room could tweak the dials to create their desired outcome is just more evidence that the Fatal Conceit continues to reign supreme.

They're engaged in frenetic dial turning, but the dials aren't connected to anything.

The median voter does not know who Ben Bernanke is, doesn't know what the Federal Reserve does or why, and doesn't look to the Fed to create jobs. But that ignorance is of no consequence because the Fed actually has no job creating power.

Right now, the main job of everyone in Washington DC is keeping their job. They either want to appear to be effective or to be invisible.

Not only that, but we are supposed to believe that if they dial inflation a bit too fast (damn controls never work) they would be able to stop it at will.

And the 70s were not even that long ago...

There's no net money creation, but banks get hit with a flatter yield curve which will almost certainly slow credit creation and limit their ability to build equity through profit retention. Frank-Dodd didn't help in that capacity either.

The policy responses to the financial crisis have been insane. Banks were too risky, so let's limit their ability to hedge their risks with derivatives. And let's regulate the only possible counterparties who are willing to take that risk- hedge funds. Banks need more equity? Let's do everyting we can to make them less profitable. Crisis was caused by government subsidized housing loans that fueled a real estate bubble? Let's not touch that at all. Up to this point, the fed was the only governing entity that made any sense. Now they're going off the deep end too.

2. The issue with inflation is really purchasing power, something that inflation hawks try to ignore (at their own peril). Maybe they should just state that wages won't inflate as fast as core but that is ok because we are trying to inflate our way out of debt (balance sheet recession). But what do I know?

7. +1! You have to wonder what would have happened if Luke had listened to Yoda and not gone to Cloud City. After all, Yoda was seriously wrong before. What Would Mace Windu Do?

Good point. For all of Yoda's prescience and wisdom, he noticed NOTHING coming. He frequently gave bad advice and made bad decisions.

Imagine if he had allowed Anakin to become a Jedi master and sit on the council. Anakin might not have felt so bitter and rejected. He might have understood why they were so suspicious of the Chancellor and the Senate. They should have been more tolerant of his desire for heterosexual marriage and fatherhood.

Anakin joined the Sith to stop his wife's death, but that decision caused her death.

They all failed to properly mentor the Chosen One.

It's only a conundrum from the point of view of the blind.

the prophecy was going to be fulfilled either way..darkness was going to come into balance with th light. Just as foxes always coem into balance with the rabbits and vice versa.

If the prophecy was inevitable, then why fight it?

The prophecy was than Anakin was the chosen one who would destroy the Sith. Yoda should have trusted that belief instead of fighting it. Anakin, on the council, might have destroyed the Chancellor before he became Emperor, sparing millions of lives.

Right, going to Cloud City was clearly the correct choice. Yoda said Luke's friends would die if he went; they didn't.

Clearly this is one of Tyler's subtle ways of backhanded endorsing a theory-- here he's endorsing Caplan's signaling theory.

Yoda wanted to see how strong Luke's convictions/instincts were. He knew there wasn't enough time to have him properly trained before the Empire quashed the rebellion.

The correct answer is that everybody just wanted to die in front of Luke. Die in front of Luke, and you get a magical ghost body.

It's the Luke Side of the Force.

Something was fishy. He returns and says "Whazzup, mesa back!" and Yoda says "No more training do you need, what you need to do is go fight Vader."

I just feel bad for the poor guy in the bar who got his arm cut off by Ben for no reason.

Since when is the Fed supposed to care what the median voter thinks? And isn't that exactly the point of Fed independence -- to do the right thing whether it's politically popular or not? And wouldn't political sentiment change if it was successful?

There is something really strange about saying that the Fed can't act because it's politically unpopular.

There is something really strange about saying that the Fed can’t act because it’s politically unpopular.

Sure. But to be consistent, if you believe this then there's nothing really wrong with the GOP leaders' letter either; the Fed can just ignore it, do the right thing, and political sentiment will change if it is successful.

they want to crash the economy now to teach the "tea-party" a they pull the big crash lever and complain that anti-fed people made them do it....Then Bernank can shout: "see you should shut up, stop complaining and listen to us central planners from now on"

No, that's not credible. It's as silly as the people on the Left who claim that the Republicans and the Tea Partiers want disaster. (Cue argument about wanting Obama to fail, followed by response about "never waste a crisis", etc.)

Yes, that's correct -- the Fed shouldn't care much about politics. But what's also true is that economists shouldn't care much about inflation -- rather, they should care a heck of a lot about expected inflation. Cowen is grasping at straws here. He sees inflation expectations falling off a cliff, but chooses to look at only the "here and the now." Why? I'm not exactly sure. Clearly, the market is saying that, all along, the deflationary forces have been stronger than the inflationary forces. The run-up in commodities in the first half was a textbook example about how economists shouldn't focus too much on the "here and the now."

The real question is, when will Cowen and those who were predicting drastically higher inflation admit that they were wrong? When will they admit that they threw the Econ101 textbook in the trash in recent years, and have made silly, gut-based prognostications about the economy? I hope soon.

The real question is, when will Cowen and those who were predicting drastically higher inflation admit that they were wrong?

I'm sorry, Joe, can you please point me to where Tyler predicted drastically higher inflation? I don't remember him doing so. Isn't he stating in his post that the "inflationists" predicting that were wrong?

Ron Suskind is just wrong. Obama knows TFP backwards and forwards. He is even consulting with CERN over the FTL particle as we write.

Does TFP include per hour labor productivity? Or does an increase in per hour labor productivity result in an increase of the exponent on L?

I think we should all be a whole lot more concerned about the cluelessness of the president's economic team than the cluelessness of the president. I expect Obama to be clueless. I'm just gobsmacked that the economists failed utterly to listen to employers. I realize people fall in love with their theories and models. But at some point, simple common sense has to kick in.

Employers keep making the same point over and over. It's the fear of crushing regulation and uncertainty about the future that keeps them from hiring. If neither interest rate levels nor govt spending levels address these fears, neither is going to make a difference. A little bit of listening would go a long, long way.

A bad analogy, I know, but these clueless economic conversations in the White House sound something like a man whose wife wants a divorce because he won't stop cheating on her. Husband seeks advice from friends and they debate whether buying her roses or a new dress would convince her to stop the divorce. Dumb and dumber.

I expect Obama to be clueless. I’m just gobsmacked that the economists failed utterly to listen to employers.

But in the same way, I don't blame Obama for making the mistake than an intelligent non-economist would make. I blame him for failing utterly to listen to his own economists on economics, as the book makes clear. The President isn't, and can't be, an expert on everything. That's okay, that's why he has advisors. Refusing to listen to them in their bailiwick is blameworthy.

Apparently he believes his own press clippings.

Ewok World = the Forest Moon of Endor, or the Sanctuary Moon.

Median voter cares more about inflation? Last time I checked, most Americans were net debtors, not net savers, given the nature of income inequality in the US and the existing current account deficit.

Interesting conjecture but some further explanation is needed.

I provided links to three polls up above demonstrating that Independents are far closer (nearly indistinguishable) to Republicans than to Democrats on inflation. They may be wrong (I think that they are), but the median voter does care more about inflation.

Yep. Underwater (or just plain low equity) home owners ought to be praying for inflation, specially those on fixed interest rate mortgage.

Good point.

I suspect people are more sensitive to prices than to their debt deflating away. This may not be rational, or it may be because they do not expect wage gains to follow.

Come to think of it, that's sort of the point here, isn't it? Reduce unemployment by reducing real wages?

Well, having lived in a country with hyper inflation the problem here is just that people don't like uncertainty. Debt is bad but for most cases it doesn't go up (unless you were planning to use your house to pay for it - oh well). Inflation is a chaotic and very stressful thing. You don't know if your employer will give you raises every month to account for inflation. People don't want to keep revising their investments monthly to make sure that they are not actually losing money.

I think it is easy to forget just how difficult it was to tame inflation and how uncertain people were about Reagan's plan to do so. Not just regular people but many economists too. like I said above, the 70s were not so long ago. I think at some level people still remember it.

People seem to be operating under the assumption that higher inflation would lower unemployment. Didn't this already get disproved.

The money drop would provide the funds necessary to pay for inflation if that is what it resulted in so would not be inflationary in any real sense, that is why we should legalize it.

This talk about what voters think they want is stupid. They don't know what they want. They prefer a better economy to a worse economy, but the fact they can't articulate that means nothing.

As Socrates said the problem with democracy is either 1) people won't know what they want or 2) they will know what they want and vote for it.

Why can't someone simply explain to voters that the only way that more money drives inflation is if YOU HAVE MORE MONEY to bid prices up? Jesus christ fuck shit. As dumb as voters might be, they aren't as dumb as the pundits & politicians treat them.

A $50/hr. minimum wage would keep "real wages" high, but through higher unemployment. Eventually labor demand becomes more elastic and the $50/hr. labor is replaced by capital. Unemployment would keep increasing until only those who can operate all the new capital are worth $50/hr. Real economic production would absolutely plummet.

With wage rigidity, we have the same thing with real wages that are above market levels. With sticky wages and prices (since wages are the main component in prices), unemployment and decline in real production declines are given by the market's elasticity. As time goes by, one of two things happens:

1. Average wages become more flexible, thus decreasing unemployment.

2. If wages do not decrease enough, companies expand their investment in capital. Eventually unemployment reaches the point where only successful capital operators remain employed.

The increased investment in software and other equipment clearly shows that private companies have gone from labor to capital to remain competitive instead of decreasing wages. Then people say that unemployment is "structural" because all the unemployed people cannot effectively operate the capital, but that's exactly what you would expect.

There's a reason why the private market had a certain labor vs. capital mix in 2007. With gradually expansive monetary policy 1982-2007, the market settled on that mix to optimize real economic production given our resources. But with the minimum wage or rigid wage market failures in the labor market, we have a suboptimal level of real economic production and go too far to capital over labor. Instead of wishing for a parallel world where wages are not rigid, shouldn't we keep MV at the same growth we had 1982-2007 and let market wages prevail instead of too-high real wages?

"Today price inflation will accelerate real wage erosion, or at least is perceived so, who wants to take credit for that?"

Well, workers are really resisting your solution of reduced nominal wages and incomes across the board without reducing the amount of their debt.

At least with higher inflation the real debt is also reduced as well, and to the degree the debt is on property with inflating prices, the debt can be discharged by selling the property at a gain.

Ron Suskind is writing from the position of a big government socialist with the leader having near dictatorial power.

For example, he claims Obama wanted the Treasury to nationalize the big banks - he doesn't use that word, but for Treasury to take them over and dismantle them, that's what it amounts to. FDIC is able to nationalize banks based on fairly well defined rules which define the assets and liabilities in clear terms, and then specifies the process for disposing of those assets, with limited government operation if required to limit losses. But for bank holding companies, no similar clarity exists

More generally, Suskind demonstrates a total lack of knowledge about the Constitution as realized in the way Congress operates, so Suskind argues Obama failed to exercise the powers of Congress as if they were presidential powers.

And Suskind suggests by implication that a different set of economists would have offered a real solution, with Volcker apparently being the economist in mind, a man who would presumable provide the instructions for Obama to nationalize everything so the banks would clean up the debt and corporations would invest in the US and create jobs.

The past five years has changed economics: if you asked 10 economists to explain the economy over the past five years, instead of 11 answers you'll will have received 25 answers. And the very few economists who answer consistently are totally ignored by virtually everyone. But for Suskind, such a view would not serve his narrative that a single man with the right stuff would have just fixed everything in two years without needing to content with Congress, the American people, the global corporations, the rest of the world's nations, their leaders, and people.

In one fell swoop he destroyed banking stocks further and managed to remove bits of long term arbitrage.
Now, we will see new bubbles forming.

In other news, Gold is now crashing.

Every bubble, in its time...

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