Finding a way to deliver more accommodationwhether it is monetary
or fiscalis particularly important now because delays in reducing
unemployment are costly. An unusually large percentage of the unemployed
have been without work for quite an extended period of time; their
skills can become less current or even deteriorate, leaving affected
workers whose productivity has eroded with permanent scars on their
lifetime earnings. And any resulting lower aggregate productivity also
weighs on potential output, wages and profits for the economy as a
whole. The damage intensifies the longer that unemployment remains high.
Failure to act aggressively now will lower the capacity of the economy
for many years to come.
IV. Recurring Themes
At this point, I would like to briefly touch on several recurring
questions and themes that come up whenever I discuss my views on the
economy and monetary policy.
A. Symmetric inflation target and balanced policy
Let’s start with policy. I can’t tell you how often people look at
me in abject horror when I say that we should adopt a conditional policy
that tolerates the risk of inflation exceeding our target by as much as
1 percentage point. How can I accept inflation rising above our stated
target? Isn’t this blasphemy for a central banker?
As you know, in January we announced a specific number — 2 percent
— for our inflation objective. At the same time, we also said that
policy would take a balanced approach in achieving the two legs of the
Federal Reserve’s dual mandatemaximum employment and price stability. I
strongly support these announcements. But questions still remain about
the specifics of how policy will be implemented under this framework.
As Chairman Bernanke (2012) stated at his last press conference,
the 2 percent inflation goal is a symmetric objective and not a ceiling
on inflation. Symmetry means that inflation below 2 percent should be
viewed as the same policy miss as if inflation overran 2 percent by
equal amount. However, if we disproportionately recoil at inflation a
little above 2 percent versus a little below, then we are not
symmetrically weighing policy misses. And there is some risk of this
misperception taking hold, since in the FOMC’s Summary of Economic
Projections (SEP), several participants’ forecasts have the funds rate
rising before 2014, even though throughout the projection period
inflation is at or below 2 percent and unemployment is well above the
sustainable rate indicated by the long-run projections.
To me, a symmetric inflation goal and a balanced approach to policy
means that if we are missing by a large mark on our employment mandate,
but are close to our inflation target, then we should be willing to
undertake policies that could substantially reduce the employment gap
but run the risk of a modest, transitory rise in inflation that remains
within a reasonable tolerance range. The 7/3 threshold policy I have
been advocating is such a plan under which I expect the sum of the
resulting two misses would be less than the one miss under a less
accommodative policy.
I believe the FOMC can do better at describing our thinking with
respect to tolerance bands around our long-run inflation and
unemployment goals. Clarification would increase both transparency and
accountability. Importantly, it would help markets better anticipate Fed
actions, creating one less source of risk for economic agents to manage.
B. Inflation
Now let’s turn to the measurement of inflation. As I mentioned
earlier, over the past year consumer price inflation, as measured by the
PCE index for total consumption expenditures, has been 1.8 percent.
Nevertheless, many, many people express disbelief over these small
reported numbers: Surely inflation is much higher! For example, I recall
Chairman Bernanke being quizzed by Congressman Ron Paul not too long
ago. Ron Paul said something like, Mr. Chairman, you say that inflation
is about 2 percent, and I say that it is about 9 percent — OK, let’s
split the difference and say that inflation is 5 percent!
The sentiments expressed by this exchange resonate with many people.
Some prices have gone up by quite a lot: Gas prices are high, food
prices have increased and deals are hard to find. But the official data
say that when you add up all the numbers, weighted by the appropriate
expenditure shares, the total PCE inflation was 1.8 percent over the
past year.
I could go on at length on these issues. But the brief points I
wish to make are these:
–We use the term inflation to refer to the effects of monetary
phenomena; this means inflation is a broad-based and sustained growth in
prices.
–An increase in the relative price of a single good, like oil,
against all other prices is then not monetary inflation.
–Behavioral finance shows that retail investors prefer to avoid
the pain of losses even more than they enjoy the satisfaction of
similarly sized investment gains. Likewise, consumers wish to avoid the
recurring ache of higher gas and food prices. Prices of many goods and
services have declined — like those for televisions, computers and
entertainment options in general — but the satisfaction that consumers
feel from these infrequent purchases isn’t enough to offset the losses
they perceive in their daily shopping.
–Although you might have concerns about a variety of government
entities, the Bureau of Labor Statistics and the Bureau of Economic
Analysis are among the best statistical organizations around. They are
responsible for collecting and publishing high-quality inflation data.
–And when researchers do come up with quibbles, they are not on
the order of percentage points, and more often, they are in terms of
overstating, not understating, inflation.
C. Nominal long-term Treasury rates
At this point in the evening, experience tells me that many folks
who were initially skeptical that inflation pressures are low are still
skeptical. And after all, there’s another important elephant in the
room, right? The Fed’s balance sheet has ballooned from a mere $800
billion in August 2007 to almost $3 trillion today: With an explosion in
the monetary base like this, inflation must be just around the corner,
right? Despite the fact that this prediction has been around since
mid-2009 and three years later it has not come close to fruition, it’s
still early days, right?
The argument that inflation is imminent faces an enormous uphill
battle these days, and a single number captures this concern very well:
1.45 percent. The ten-year Treasury rate was 1.45 percent as of June 1.
This is unprecedented in the post-World War II economy, and it is wildly
inconsistent with rising inflation over the timeframe that monetary
policy is concerned with, such as the next ten years.
What do such low rates signify? To start, the nominal short-term
interest rate is the sum of the real interest rate plus expected
inflation. In turn, long-term interest rates are the average of expected
future short-term rates plus a term premium, or risk premium. There are
a variety of ways to estimate this decomposition; and they all indicate
that today all three piecesexpected real rates, expected inflation and
the risk premiaappear to be quite low.
-more- (2 of 3)
** MNI Washington Bureau: 202-371-2121 **
[TOPICS: M$U$$$,MMUFE$,MGU$$$,MFU$$$]
