The president of the Federal Reserve Bank of San Francisco has recommended that the FOMC [Federal Open Market Committee] put the pedal to the metal. There has to be far more monetary stimulus. This is Keynesianism running amok.
He made a major speech recently. As a good Keynesian, he sees the trade-off between fiat money and unemployment.
This evening, I’ll try to give you a real sense of how I, and many central bankers, think about monetary policy. We must make difficult decisions in the face of intense pressures and conflicting demands. For example, at any given time, should we worry more about unemployment or inflation? What are the most dangerous risks to the economy and how can we defuse them? My aim is to explain some of the ways we analyze such questions. This is a particularly compelling subject now, more than two-and-a-half years into a lackluster recovery marked by weak demand and a still very high unemployment rate.
There is no such trade-off in a free market economy. The trade-off begins after fractional reserve banks increase the supply of fiat money, promoting an unsustainable boom. This is what the Federal Reserve has done.
This speech was pure PR flak. He is a pro-inflation Keynesian, and he wants the others on the FOMC to follow his lead.
Let me start with the Fed’s mission. It’s often said that Congress assigned the Federal Reserve a dual mandate: maximum employment and stable prices. But, that’s not quite accurate. In fact, the Fed has a triple mandate. Section 2A of the Federal Reserve Act calls on the Fed to maintain growth of money and credit consistent—and I quote—“with the economy’s long-run potential to increase production, so as to promote effectively the goals of maximum employment, stable prices, and moderate long-term interest rates.”
These are excellent and desirable aspirations. However, they fall short in providing specifics. After all, what does it mean to say “maximum” employment or “stable prices”? Is a 4 percent interest rate moderate? Six percent? Ten percent? Moreover, what do we do if these goals are in conflict with each other?
To answer these questions, let’s take a closer at each individual goal in turn. Let me start with the goal of stable prices. Now, taken literally, stable prices would seem to imply that the costs of all goods and services should be frozen in time. But, that can’t be right. After all, prices fluctuate all the time in response to shifts in supply and demand.
He is correct. He refused to say why. The goal is illegitimate theoretically. The free market sets individual prices. The central bank should not even exist. But he does not draw this conclusion.
Relative price movements—with some prices going up and others going down—are a natural part of a well-functioning market economy. It’s the way markets signal which goods are scarce and which are relatively abundant.
Correct. This was the view of F. A. Hayek. But the correct conclusion — no central bank is needed — is not considered acceptable by Keynesians.
Instead, the Fed looks at price stability in an overall, or average, sense. We strive to make sure that the average prices of a comprehensive set of consumer goods and services don’t change much from month to month or year to year. The well-known consumer price index is one measure of average prices. We at the Fed tend to focus more on the somewhat broader personal consumption expenditures, or PCE, price index, which is reported along with the GDP data.
So, a bunch of Ph.D. economists think they can run the economy better than the free market can. They are wrong. Today’s economy is evidence.
He called for perpetual price inflation.
What objective should we seek for the rate of increase of average prices? Should we strive for no change at all, that is, zero inflation? At first blush, that seems sensible. But, there are a number of reasons why aiming for zero inflation would be too low and inconsistent with our maximum employment mandate. Here I’ll mention two.
First, a small amount of inflation can help grease the wheels of the labor market. There is considerable evidence that nominal wages don’t easily fall even when demand is weak, something economists call downward wage rigidity. In other words, it’s unusual for workers to have the dollar value of their wages reduced. In this regard, wages are very different from, say, airline ticket prices, which are quickly discounted when seats can’t be filled. Weak labor demand may necessitate a reduction in real wages, that is, wages adjusted for inflation. Even if the nominal, or dollar value, of wages won’t budge, the real wage will fall as prices rise. As a result, a little bit of inflation can help the labor market adjust to negative shocks and, in this way, help keep employment closer to its maximum level.
Second, a small amount of inflation gives the Fed a little more maneuvering room to respond to negative shocks to the economy. The problem is that nominal interest rates can’t go below zero. Economists refer to that limit as the zero lower bound. Let me define terms. The nominal interest rate can be divided into its two components: the real, or inflation-adjusted, interest rate; and expected inflation. A little bit of inflation tends to raise nominal rates on average in order to provide a positive yield to investors. That gives the Fed more room to lower interest rates in a recession before hitting the zero lower bound.The more we can lower interest rates when appropriate, the more we can stimulate the economy and boost employment when needed. That helps us keep closer to our maximum employment goal. Research on this question has found that an inflation objective of 2 percent or higher generally provides plenty of maneuvering room for the Fed, except in the most severe recessions.
So a little bit of inflation may be desirable. But, of course, too much inflation would be inconsistent with our price stability mandate. Moreover, high inflation carries with it considerable costs in terms of economic efficiency. Weighing these considerations, my fellow Fed policymakers and I have concluded that a 2 percent inflation rate—as measured by the personal consumption expenditures price index—is most consistent, over the longer run, with our mandate. It represents the best compromise between having inflation close to zero, but not so low that downward nominal wage rigidity or the zero lower bound pose significant problems for the economy. The Federal Reserve’s policy body, the Federal Open Market Committee, or FOMC, officially announced this objective of 2 percent inflation in a statement entitled “Longer-Run Goals and Policy Strategy” released following our most recent meeting in January.
After a lot of footnotes showing that the U.S. economy has high unemployment — duh — he concluded this.
What does this tell us about where monetary policy should be now? Inflation in 2012 and 2013 is likely to come in around 1½ percent, below the FOMC’s 2 percent target. And clearly, with unemployment at 8.3 percent, we are very far from maximum employment. At the San Francisco Fed, our forecast is that the unemployment rate will remain well over 7 percent for several more years.
This is a situation in which there’s no conflict between maximum employment and price stability. With regard to both of the Fed’s mandates, it’s vital that we keep the monetary policy throttle wide open. This will help lower unemployment and raise inflation back toward levels consistent with our mandates. And we want to do so quickly to minimize total economic damage. The longer we miss our objectives, the larger the cumulative loss to the economy.
This is truly an extraordinary time for monetary policy. I’ve talked about some of the tradeoffs central bankers face. But I don’t see such tradeoffs today. Now is one of those moments when everything points in the same direction. The Fed is committed to achieving maximum employment and price stability. And we’re doing everything in our power to move towards those goals. Thank you very much.
It appears likely that he speaks for a majority of the FOMC’s members. The FOMC will continue to inflate.