Don’t blame the Fed so much

Slow labor market recovery does not have to mean the core fix is or was nominal in nature, even if the original negative shock was nominal:

Recent critiques have demonstrated that existing attempts to account for the unemployment volatility puzzle of search models are inconsistent with the procylicality of the opportunity cost of employment, the cyclicality of wages, and the volatility of risk-free rates. We propose a model that is immune to these critiques and solves this puzzle by allowing for preferences that generate time-varying risk over the cycle, and so account for observed asset pricing fluctuations, and for human capital accumulation on the job, consistent with existing estimates of returns to labor market experience. Our model reproduces the observed fluctuations in unemployment because hiring a worker is a risky investment with long-duration surplus flows. Intuitively, since the price of risk in our model sharply increases in recessions as observed in the data, the benefit from creating new matches greatly drops, leading to a large decline in job vacancies and an increase in unemployment of the same magnitude as in the data.

That is from a new NBER working paper by Patrick J. Kehoe, Pierlauro Lopez, Virgiliu Midrigan, and Elena Pastorino.  Essentially it is a story of real stickiness, institutional failure yes but not primarily nominal in nature.

Perhaps more explicitly yet, from the new AER Macro journal, by Sylvain Leduc and Zheng Liu:

We show that cyclical fluctuations in search and recruiting intensity are quantitatively important for explaining the weak job recovery from the Great Recession. We demonstrate this result using an estimated labor search model that features endogenous search and recruiting intensity. Since the textbook model with free entry implies constant recruiting intensity, we introduce a cost of vacancy creation, so that firms respond to aggregate shocks by adjusting both vacancies and recruiting intensity. Fluctuations in search and recruiting intensity driven by shocks to productivity and the discount factor help bridge the gap between the actual and model-predicted job-filling rate.

Again, a form of real stickiness more than nominal stickiness.  The claim here is not that the market is doing a perfect job, or that the Great Depression was all about a big holiday, or something about video games that you might see mocked on Twitter.  There is a very real and non-Pareto optimal coordination problem.  Still, this model does not suggest that “lower interest rates” or a higher price inflation target from the Fed, say circa 2015, would have led to a quicker labor market recovery.

Even though the original shock had a huge negative blow to ngdp as a major part of it (which could have been countered more effectively by the Fed at the time).


I am not sure there is any analytical inaccuracy I see on Twitter more often than this one, namely to blame the Fed for being too conservative with monetary policy over the last few years.

And please note these pieces are not weird innovations, they are at the core of modern labor and macro and they are using fully standard methods.  Yet the implications of such search models are hardly ever explored on social media, not even on Facebook or Instagram!  You have a better chance finding them analyzed on


Twitter, the place that proves the truth that not only someone, but just about everyone, is wrong on the Internet.


Comment Of The Century.

Relying on Thomas Sargent: Beware of theorists bearing free parameters!

Do I understand this correctly, that this theory suggests that higher risk during recessions, and in particular a loss in confidence about the future prospects for a business, causes businesses to cut back on hiring? How does this differ from Keynes’s Animal Spirits? And why wouldn’t it be solved by an aggressive monetary policy?

" And why wouldn’t it be solved by an aggressive monetary policy?"

If the businessman sees an attempt by the Central Bank or the government to fool him then he might decide not to be fooled.

This is something of a surprise. A welcome surprise. Cowen does have an independent streak. No, I don't expect Cowen to because a soldier in the war against asset bubbles, but at least it takes the focus off of the Fed and monetary policy. During and following a financial crisis the Fed can stop the fall in asset prices, restore confidence in the financial system, and help restore asset prices once the crisis has passed, but the Fed cannot force business to invest or hire. Indeed, the lesson of the recent crisis and recovery is that the Fed's tool box is limited, that the Fed can affect asset prices (up and down), that investors can rely on the Fed to restore and increase asset prices, and that investors who realize this can generate enormous profits from rising asset prices by investing in assets before prices are restores. Investing in productive capital and hiring, not so much. Indeed, we have come to rely on rising asset prices for prosperity. Our Austrian friends inform us that it will not end well. Such are the limits of the Fed and monetary policy. [To be fair, if the alternative is collapsing asset prices and a depression, I'll take what the Fed can offer.]

Cheer up, Sourpuss.

The US hasn't had a recession since 2008/2009. Is that over-ten years a Fed record?

It might have worked if they Fed had stuck to central banking.

The problems aren't so much the "limits of the Fed and monetary policy." The problems are too much Fed discretion/power/responsibilities and concomitant larger failures in central planning. Note: The Fed is not only doing "central banking." (lender of last resort, bank supervision) It's doing central planning.

Central planning (often wrong Fed open market operations, interest rate/yield curve manipulation; asset/stock price levitation; QE's/Asset purchases/money printing) not central banking. Since 1913 inception, there have been 18 depressions/recessions (including Great Depression and Great Recession) - stock market crashes, excessive unemployment, business bankruptcies, wealth destruction. Sectors (Wall Street, capital goods, real estate) that receive Fed largesse/easy credit/printed money boom, bubble, bust = every thing about which the "Austrians" warned.

Because if there hadn't been a Fed, none of those things would have happened since 1913. Come on dude.

In the sixty-four years prior to social security, unemployment typically ranged from 12% to 25% during seventeen economic downturns. After 1949, unemployment never once reached 12%.

Former Fed Chair Marriner Eccles felt the Federal Reserve alone was not capable of preventing depressions. A properly managed plan of government expenditures (social security, unemployment insurance, etc.) was essential. So too was a system of taxation conducive to a more equitable distribution of income.

If the Fed was expected to take more aggressive action in the future the initial shock to NGDP would not have been as large. You are acting just like the dinosaur Keynsians or the MMT people. Think about policy as coherent whole past and future.

The Fed is also limited when the administration promotes policies at cross-purposes with the Fed. Today, the Fed is expected to maintain a strong dollar in order to help fund Trump's trillion dollar deficits even as manufacturing output is falling due to Trump's tariffs on imported intermediate goods and, yes, the strong dollar. Houdini couldn't come up with a monetary policy to accommodate policies that are at cross-purposes.

With manufacturing output falling, the economy is increasingly dependent on consumer spending, which in turn is partly dependent on rising asset prices and the wealth effect, putting pressure on the Fed to maintain asset prices, for if asset prices fall, consumer confidence and spending will fall. Simply setting growth or inflation targets ignores the reality that we have come to rely on the Fed for policies that are at cross-purposes.

Many liberals nowadays are weirdly adopting an Austrian explanation for the financial crisis. Real Austrians want the government to stand aside and let these crises play out as penance for past sins, just as Andrew Mellon (presumably an Austrian hero of years) recommended in the wake of The Great Depression.

You have this incoherent obsession with asset prices, but you fail to understand that returns on the S&P 500 over the past 20 years were only about 6% per year, by far the worst performance in any 20-year period post-WWII. You don't understand that lower interest rates are a real phenomenon around the globe, largely a demographic phenomenon and not the result of central bank policy. And low interest rates absolutely justify current asset prices.

Maybe you got out of the market when Krugman told you to and that explains your bitterness about asset prices and theory that they are simply the result of the machinations of the Fed.

If you were really concerned about regular people, you'd be applauding the fact that, in the past 10 years, the US economy has added more than 22 million jobs and that real household MEDIAN income is up 13% since 2012 (just 6 years.)

The American people did this. They deserve the credit for this. Following your Austrian advice, this would not have happened. The most that can be said for the Fed is they didn't let the bus crash like Austrians wanted, which is their only job anyway.

Outstanding, +10 internet points

"I am not sure there is any analytical inaccuracy I see on Twitter more often than this one, namely to blame the Fed for being too conservative with monetary policy over the last few years."

I almost never see this error being made. I figure it's because core PCE has been right around 2 percent over the last few years. That said, if you favor price level targeting, then that's still too little because there has not been any make-up inflation.

In any case, a bit bizarre to be making such strong and self-congratulatory assertions about a misconception with dubious existence properties by strangely framing the issue of central bank behavior with no appeal to price level stability or inflation. And by bizarre, I mean silly.

How about weird? Can Tyler finally be called weird?

Agreed. All kinds of nonsense is thrown around on Twitter, but, from what I see, most Fed criticism (and the consensus view on Wall Street, AFAICT) is all about bubble theory and unsustainability and similar sandwich-board wearing doom theory, rather than arguments that the recovery should have been faster or more robust.

It seems to me that slow and steady economic growth can run indefinitely. We shall see.

The investor class has come to rely on the Fed to juice asset prices, but rationalize it as having nothing to do with juicing asset prices but instead promoting employment and economic growth. People can rationalize just about anything when they believe it's in their best interest. Cowen charts his own independent path: one can tell because he pisses off just about everybody at one time or another.

There are a few people who Cowen is exceedingly careful not to piss off.

Labor markets have the intermediate, the 'recruiter'. I haven't found the abstract tree model, it is a tough nut to crack, I agree with that.

In the 2008 crash the last state to recover in employment was California, and the delay was needed because of the pension issue. It was a public sector drag, labor was a risk to pension payments for quite some time until the market got pumped enough to generate returns..

This is a very Arnold Kling PSST story, is it not? If your characterization of this work as totally mainstream is right, seems like we ought to consider the general PSST concept more mainstream as well.

"something about video games that you might see mocked on Twitter"

Tyler aren't you one of the video game proponents that was mocked on Twitter?

My favorite scheme of the monetarists it to combine NGDP targeting with a futures market, and a commitment of the Fed to buy or sell if the futures market falls below (buy) or above (sell) target. Some would limit buying and selling to government debt, but others would go the full monty and include equities. And we have deficient investment in productive capital now, and these folks want to provide a government guarantee for asset prices. They actually believe it's just a better way to implement monetary policy. And they think the MMTers are nuts.

Warning: The current boom having been put on steroids by huge central bank liquidity injections, low interest rates, and Basel Committee’s procyclical risk weighted bank capital requirements, could end in a horrific Minsky moment bust equally put on steroids.

The globalists wanted globalized capital markets, and now we have them. But that means any particular central,bank is operating in a globalized capital market and financial system. That means the actions of any lone central bank may or may not be offset by the actions of other central banks, and that central banks have to be analyzed as a group, not independently.

Thus, trying to stimulate the economy of a particular nation through central-bank stimulus is likely to result in something of a mush.

The way to stimulate the economy in a defined geographic area, such as that of a nation, is to engage in helicopter drops or fiscal stimulus.

Think of the European Central Bank trying to revive the economy of Greece.

The referenced study is nearly useless.

Be careful. Apparently 330 people are killed every year in the United States by falls from rooftops.

So is this Tyler shifting to sharp disagreement with Sumner? It seems like Scott Sumner would not agree with Tyler's take here at all.

Could explain why the supply side boost from the trump tax cut was so huge

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