The figures below document this failure by the FOMC. The first figure shows the 5-year ‘breakeven’ or expected inflation rate. This is the difference between the 5-year nominal treasury yield and the 5-year TIPs yield and is suppose to reflect treasury market’s forecast for the average annual inflation rate over the next five years. The figure shows that prior to the September 16 FOMC meeting this spread declined from a high of 2.72 percent in early July to 1.23 percent on September 15. That is a decline of 1.23 percent over the two and half months leading up to the September FOMC meeting. This forward looking measure was screaming trouble ahead, but the FOMC ignored it.
He includes several charts. Read the whole thing. If you tell me that the expected inflation rate has declined from 2.72 percent to 1.23 percent, I think that this is somewhat bearish news. But it is not the end of the world.
See also Matt O’Brien‘s reading of the Fed minutes of 2008. It is quite stunning to consider Ben Bernanke’s behavior during September. On the one hand, he participated in the Paulson Panic, supporting TARP and going all out to save the banks. On the other hand he thought that the risks of inflation and recession were relatively balanced. It is consistent with my view of how the Fed looks at the world, which is through the eyes of the big NY financial institutions.
Still, the way I see it, the attempt to attribute the Great Recession to monetary policy seems forced. The people who believe it really believe it. And I cannot tell you that it is absolutely impossible that a small change in expected inflation can send the economy down the toilet. But I think that the human bias to try to find simple, single causes for things is something to correct for here.
As someone who thinks the Fed was highly complicit in the boom/bust, I think you can hold that view without being a single-cause simpleton. It’s true that markets can get out of hand without monetary stimulus, and housing markets had an assist from govt. policies (of the left and right) as well, but the Fed is ultimately responsible for systemic risk and everything it did through Greenspan & Bernanke was in the direction of greater systemic risk. They consistently goosed up liquidity (and orchestrated bailouts) when markets faltered (the seeing-things-through-the-eyes-of-big-NY-institutions that you talk about); basically ignored the collapse in lending standards even as they were the only institution mandated to do something about it (via regulation); and held interest rates way below where they would be in a free market because of an inflation target and deflation phobia that caused them to completely misread the risks that were building.
If you went back to 1987 and populated the FOMC with folks who are sensitive to credit booms, bubbles and moral hazard (as opposed to kicking them off advisory committees as they reportedly did to Shiller), it’s hard to imagine that the last 25 years playing out as it did. Even adding people who understand that house prices can go down on a nationwide basis (Bernanke pretty much denied this) and that mortgage debt, too, can fall (Greenspan dismissed that one) should have made some difference.
BTW, I’m a huge fan of the site and adding my 2 cents only because I don’t follow your perspective on the Fed’s impact and potency. IMO an institution that can control interest rates, create all types of liquidity programs, regulate lending nationwide, oversee NY banks and set capital and reserve requirements is a pretty powerful institution.
F.F. Wiley,
Arnold Kling is talking about the views of Scott Sumner, David Beckworth and other market monetarists, not your views.
Your view–which includes obsession with interest rates–is not very persuasive. And I’m sure Kling is too smart to agree with your view.
The idea that interest rates are “artificially low” right now doesn’t make sense.
If the Fed tightens aggressively, NGDP growth expectations and stock prices will fall. As a result, long-term interest rates will go down.
And if the Fed eases aggressively, NGDP growth expectations and stock prices will increase. As a result, long-term interest rates will increase.
In other words, the idea that interest rates are “artificially low” is exactly backwards. Understand? I’m sure Arnold Kling does.
Ah, I was thinking back to “Karl Smith’s Question” on monetary policy more generally and other posts – didn’t make the connection to the NGDP crowd on this one.
My mistake.
As for the other points, you (TravisV) have surely figured out from your comments on my site that I have no interest in discussing Scott Sumner’s ideas with you. No change there.
Here is a statement, extracted from the Matt O’Brien article that Arnold linked to, that seems to epitomize the “Fed caused it” bias that dominates these sorts of discussions/conclusions:
“Consumers were cutting back [by August 5, 2008 FOMC meeting], especially on big-ticket items like cars, because they couldn’t get credit.” [Emphasis and insert, mine].
The ceteris parabus assumption is ALWAYS that “… they couldn’t get credit“, which, if true, could plausibly be traced back to Fed actions/mis-actions/inaction.
The problems I have with this is:
First, Consumers weren’t cutting back spending – (see http://www.bea.gov Table 1.1.5 NGDP data. Consumption spending increased, both in nominal dollar terms, and in percentage-of-NGDP terms constantly for the period 2006 through 2012 [the last full year of data I have].)
But, beginning late 2007/early 2008, Households were reducing household debt levels – a rather rare “de-leveraging” phenomena that is just now (last quarter 2013) beginning to reverse. That household debt “de leveraging” amounts to some $2 Trillion as of now, by the way.
Second, although it’s possible that the household debt “de-leveraging” cycle that began late 2007 (and most likely earlier) was due to reduction of credit availability (the Fed’s fault), I haven’t seen anything I would consider proof – other than unsubstantiated claims.
An equally possible, and I think vastly more probable, explanation for the household debt “de-leveraging” cycle is that it is/was nominally or even entirely voluntary action on the part of households – completely irrespective of credit availability, interest rates, or Fed action/mis-action/inaction. Somehow, I never read/hear the “… because they couldn’t get credit … (the Fed’s fault)” crowd ever mention or even consider that explanation. Have you?
I agree with you that the Fed is a very influential and powerful entity. But it’s NOT powerful enough to force households or businesses to take on new debt, or even avoid de-leveraging, any time it wants.
I agree there is too much emphasis on single causes but that shouldn’t mean there are no causes and everything is irrelevant. What it highlights here I think is the need for increased automatic mechanisms to counteract instability. That is no small task as information arrives late and action can easily lead to overreaction, but the more we can create such mechanisms, especially those that work against institutional biases so there is less they need to do, the more effective they can be. It is possible these could encourage them to do even less or even counter them, but they already have this bias and we want them to do what they are already comfortable doing.
Monetary policy may be prone to misattribution for the same reason that it may be a robust “explanation”: every causal argument takes place in a monetary regime. Non-monetary arguments still imply a monetary environment that permits such effects.
In my estimation there is too little discussion from the mmt contingent on the unsustainable path that made subsequent small errors more consequential. There may be a good reason they were worried about an unseen inflation problem if they had created it. Complaints about failure to bail out are valid but indicate an asymmetry of hindsight.
The economy is very sticky, as sticky as an oil tanker making a U turn. Unsticky money measures sticky things quite well, and thus get blamed, as in shoot the messenger.