...against fictions and other tall tales

Tuesday, 25 September 2012

Marvin Goodfriend on QE3: "This is a game changer for the Fed"

From a Bloomberg interview on QE3 with Marvin Goodfriend (click on "OK"):
I think this is a game changer for the Fed. I think it's a return to what we called a few decades ago "go and stop" monetary policy, which is to say, go all-in on a low unemployment target until the actual inflation rate rises enough to alarm the public.
As previously mentioned, I'm not sold on the idea that a new round of quantitative easing (QE) by the Fed will have much impact on the US economy. So, in a way, I don't reject Goodfriend's view that QE could involve diminishing returns down the road. However, I disagree with Goodfriend in regard to the inflationary risks that QE poses in future. Here, it may be worth highlighting an important point advanced by Oscar Jorda, Moritz Schularick and Alan Taylor in their paper "When Credit Bites Back: Leverage, Business Cycles and Crises" (2011), which discusses the after-effects of financial crises from a historical perspective:
...[O]ur results speak more directly to the question of whether policy-makers risk unleashing inflationary pressures by keeping interest rates low. Looking back at business cycles in the past 140 years, we show that policy-makers have little to worry about. In the aftermath of credit-fueled expansions that end in a systemic financial crisis, downward pressures on inflation are pronounced and long-lasting. If policy-makers are aware of this typical after-effect of leverage busts, they can set policy without worrying about a phantom inflationary menace. (2011:6)
That said, the interview nonetheless contains a lot of valuable insight on the policy implications of QE3 moving forward, as well as the reasons that may have prompted FOMC members to go ahead with another round of QE right now.

Finally, I also think Goodfriend makes a valid point when he suggests that the Fed is not providing sufficient information to the public about both the specific unemployment (or any other labor market indicator) target for QE3 and the evidence to justify additional QE at this time. That Goodfriend focuses on this last point is not surprising given that he's been a longtime advocate of central bank transparency, a principle that I too find important, although for different reasons. While Goodfriend views transparency as necessary for policy effectiveness, I believe it is a commendable principle for government organizations to follow for reasons of public accountability.

References

Jorda, O., M. Schularick and A. Taylor, When Credit Bites Back: Leverage, Business Cycles and Crises, Federal Reserve Bank of San Francisco, Working Paper, November 2011.

13 comments:

  1. An excellent insert, circuit. I am actually very pleased of the Bloomberg selection, and your alertness in picking up the best that's out there.

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    1. Thanks. As you can tell, I don't always agree with Goodfriend views but he's a fantastic communicator on monetary policy issues. His analyses of intent and policy goals are always very insightful. Finally, he's got a very solid understanding of CB operations and Fed history during the last couple of decades. The interviewers (who are themselves quite bright) taped a good one here.

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  2. Visiting Canada is a blessing! Visiting FRB and finding an outstanding guest is a cherished supplement.
    I agree with KP, this was a timely insert. Marvin Goodfriend, as most will confirm, is an excellent thinker. However, I am somewhat embarrassed to be at odds with his views on the Fed and Chair Bernanke. On the typos, it is quite impossible for the Fed to quantify 'substantial'-most of the variables affecting the economy have political origins and many of those can only be resolved politically. It would be highly 'immature' to slight a quip by one of the interviewers for the Chair to assume a fiscal responsibility when the Fed's inputs are complementary. Then, as far as Chair Bernanke being the only 'mature' member of the meeting-the interviewer/commentator shows some immaturity or does not appreciate the extent of the experience seated within that organization. Here Bloomberg surprised me.

    To address the historical vision, I would venture that Chair Bernanke's context is by far more challenging than Chair Volcker's. I say that with the utmost respect to PAV. In the 80's the global economy and currency was USD dominated. There was no Euro, no EZ, no China, not anything close to China (aggregate Japan, Germany UK, France Italy) and you will note that their aggregate GNP was symbolically irrelevant with respect to the US. Capital movements were paradigmatically USD flows. Labor was more influential then, than now, hence greater the challenge. (Wilensky toned that reality best.) The level of complexity confronting decision-makers now is much more subtle than back then.The inflationary pressures being played out under Volcker were not coupled with the type of slowdown now experienced in the global economy, nor by the same type of frailty of financial markets, nor by a Congress explicitly politicized to the extent of being 'paralyzed'. I suggest that the historical comparison that Mr. Goodfriend proffers is not at all appropriate. We can certainly compare the leadership of both great individuals, but we cannot compare the structural metrics that define the operating spaces of their respective challenges and policies. In fact, your own qualifier-the reference to Jorda et al, is remarkably and deservedly significant!!!

    Finally, I welcome Mr. Goodfriend's balanced disposition in a explicating that the Fed will react to both inflation developments and the market's inflation expectations.( I modestly remind that inflation is a consequence of the market's perception of what the cost and risks of prices and credit will be.)

    To a large extent' GC very subtly suggested that Mr. Woodford's presentation was not incidental. In my opinion it was largely an 'addendum' to the Chair's speech, serving the market with the historical dimensions that characterize the Fed's policy stance. Credit to both men. So calling for more transparency is like calling for light when there's a blackout. If as all suggest we are in unexplored territory, you can only say so much. Anyways, policy is about experiment-controlled and constantly monitored-but experiment anyways. Chair Volcker proved that in the early '80s.

    I would tend to downplay Mr. Goodfriend's comments on the Fed's need to be more explicit as not pragmatic, in Mr. Goodfriend's own terms,and I do so with great reservations. Marvin Goodfriend is brilliant.

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    1. Welcome MI! I hope you enjoy/ed your time on this side of the border. I also agree that the analogy with the 1970s and 80s doesn't hold up, although I hadn't thought about your point regarding the dominance of the USD. Indeed, that's a significant difference.

      In regard to transparency, I take your point that under conditions of uncertainty this placed the Fed in a difficult position. But I like MG's comment about the need to know the *theory* that the Fed is applying. Also, Congress might find useful to know the degree of improvement in unemployment the Fed is hoping to see from QE3, as it might serve to get Congress to do more (if it is known that the Fed's target is actually quite minimal).

      Finally, yes, the Jorda et al. paper is excellent!

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  3. the dilemma is that there is no alternative theory. MG doesn't suggest one. no one does. if not QE3, what then. i don't want to sound sardonic, but the UK and the EZ are perfect examples of applying 'theory' that doesn't work. QE3, certainly experimental in the current context, has had no pejorative effects although the surmised results are longer to concretize than expected. the republican lobby accuses the FED of cronyism because the QE approach seems to target benefits towards banking and real estate. does anyone believe that the GOP would let the financial system collapse. RUBBISH! i shall modestly adhere to the position that QE is a very effective bandage without which we would face a lethal hemmorage. unfortunately policy is not always conducted according to theory. MG himself suggests that the FED is venturing into unexplored territory. as MI said, there's no light during a blackout; if someone has a match or alternative 'lighting' good! but there doesn't seem to be alternative around on the monetary front. it's not time to indulge in idle debate; it's important to 'hold a position' and give time to fiscal initiatives that will stimulate required demand at a productive level.

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    1. "the dilemma is that there is no alternative theory. MG doesn't suggest one. no one does. if not QE3, what then. i don't want to sound sardonic, but the UK and the EZ are perfect examples of applying 'theory' that doesn't work."

      Right on, JH. I entirely agree.

      But in regard to the effect of QE so far, couldn't we argue that, although it hasn't been detrimental to the US economy overall, QE's benefits have been unequally distributed across the population? As the last post shows, folks with stocks have benefited while the unemployed and home owners haven't at all. That said, I tend to agree with you, MI and Lombra (as in his interview-see earlier post): better to do something than to do nothing. I think Bernanke is doing his best. And under difficult circumstances.

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  4. First of all, let me commend you on highlighting the Jorda et al. paper. It is an important empirical analysis worth circulating to most pundits in Washington. On Marvin Goodfriend's caution, I will only add to what MI and JH have fairly noted, too much caution on a dying patient ultimately disadvantages the patient. MG, with his many years at the FED, knows this better than most GOP's.

    On the other hand, this obsession that QE can lead to inflationary contexts is somewhat irrelevant. Inflation can be triggered by as many external variables as there are monetary policy decisions. The Volcker moments! are examples of such contexts. However, if one trigger is out there, it may be oil, and I recall reading one of your many insightful posts, dating back to March 2011. A brilliant!! piece on US Strategic Petroleum Reserves, and I found this recent piece by Blake Clayton that you may find interesting given the current QE/inflation debates:
    Lessons Learned From the 2011 Strategic Petroleum Reserve Release-
    Author: Blake Clayton, Fellow for Energy and National Security

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    1. Thanks. I'm generally in favour of buffer stocks. I'll check out the CFR paper and pass it along. It looks really interesting.

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  5. @GC. I had the opportunity to look at the CFR post and found it to be a very good caution given the possible alarms on oil prices. Thanks for the lead.

    'On the other hand,' as your conjunct says, I am perplexed by your statement: "...this obsession that QE can lead to inflationary contexts is somewhat irrelevant." I presume,from having followed your previous comments that you're not implying that considerations on inflation are irrelevant.

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    1. I ref. the CFR article because it's my contention that any policy implementation must be monitored. The parametrics that determine continuing success are usually overlooked until the first glitch surfaces and then one's confronted with tackling damage or crisis.

      As far as your reservation to my statement that the inflation issue is irrelevant, I realize that not everyone may have understood my context. My point is that given the circumstances of slow growth, unrelieved unemployment, excess under-capacity and falling output, the inflation issue is really not problematic at the moment and I will dare that it will not be problematic for another 24-36 months unless some rogue behaviour on the part of an irresponsible sovereign trigger a financial crisis much more serious than 2009 in the US and 2011 in EZ. In that frame, I apologize to readers for having misled them.

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  6. Good link - I'm just curious to know what 'diminishing returns' you foresee, if not inflation. Thanks

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    1. Tim, I'm thinking of the reduced demand caused by QE removing interest income from the economy. It adds up. Also, my 'circuitiste' tendency tells me that if the employment situation in the US doesn't improve in the next couple of years, QE may exacerbate the income distribution problem given its effect don't benefit everyone equally. (I referred to this in a comment above).

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  7. Αlea jacta est by the “emperor” Draghi:

    http://failedevolution.blogspot.gr/2012/09/lea-jacta-est-by-emperor-draghi.html

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