There's a strange view out there that with unemployment above ten percent, and inflation nascent, the Fed should be thinking about raising interest rates.Yesterday Philadelphia Fed President Charles Plosser attempted to explain his view:
… several empirical studies have shown that economic slack is difficult to measure with any accuracy. So making policy decisions based on measures of such slack and particularly on forecasts of slack many quarters ahead becomes problematic.
Plosser is right that there's uncertainty about the exact degree of slack. But his conclusion — that this builds the case for raising interest rates sooner rather than later — just doesn't follow.
The standard view is that "economic slack" (which is really just central-bank-speak for unemployment) is important because a depressed economy means that workers don't have the power to ask for higher wages, intermediaries won't raise input costs, and firms find their profit margins under pressure. Enough slack yields low and stable inflation. Too much slack — as we surely have right now — leads inflation to fall.
Because high unemployment will likely persist for several years (and Plosser himself sees unemployment edging up further), most forecasters believe there's barely any chance of a serious inflationary episode in the next couple of years. But Plosser argues that we need to take account of the fact that economic slack is difficult to measure, adding uncertainty.
How does uncertainty change this analysis? Either there's more slack out there than we think, or there's less (or current forecasts are spot on). Balancing these risks means thinking through the consequences of each outcome. If there's really less slack, then inflationary pressures may well arise at some point. If this happens, the policy "mistake" of interest rates being too low in 2010 could be easily undone by higher interest rates in 2011. But what if there's actually more slack out there than we think? If this occurs, future inflation will not only be low, but it may fall to the point that deflation may become a real risk. The problem is that this mistake is not easily undone; excessively high interest rates in 2010 can't necessarily be undone by lower rates in 2011, because interest rates can't fall below zero. In fact, this "zero lower bound" is what made both the stimulus package necessary as well as the Fed's current unconventional monetary policies.
Plosser is right — there's definitely uncertainty about the inflation outlook. But the consequences of raising rates too early are just a heckuva lot harder to undo than the consequences of raising rates too little or too late.
What if there’s less slack and raising rates drives the economy back into recession? What if raising rates actually hurts our ability to sell long-term US debt because the buyers would now fear rate increases well before unemployment drops? What if raising rates pumps up the dollar enough that exports are hurt? I could list more but almost all come out against raising rates now.
What if raising rates keep the goverment spending from growing and brings long term rates down where they should be.
“"¦ several empirical studies…”
Wait a minute…either it’s “empirical” or a “study” but not both.
It seemed to me that a key part of his argument is that the Fed’s ability to control inflation is intimately tied to it’s credibility regarding it’s ability and desire to control inflation. Gold surging past $1200 suggests that credibility is in question.
Doubts about the ’standard view’ of macroeconomics are not confined to problems with measuring the output gap and are one of the reasons the Fed is in danger of losing whatever credibility it has left after it’s utter failure to perform it’s duties over the last few years. The economic slack issue appears to be the least important part of his argument to me.
Re: Comment #2… There is no evidence to show that government spending would slow if rates are raised. Congress has a funny way of continuing to spend without regard to [anything, interest rates included].
I might be wrong on this, but the only justification that I could see for this viewpoint is that there’s a fear of growing inflationary expectations. If recent measures show inflation growing despite high unemployment, then perhaps people’s expectations of inflation have shifted out, so to speak, and the fear is that even greater inflation will be necessary to produce short-term reductions in unemployment.
But I would counter with the fact that for all the uncertainty around the unemployment rate, there is probably considerable uncertainty around the inflation rate. The Philly Fed provides data sets on historical revisions in economic statistics, and I’ll be interested to check on the comparative standard errors on the two statistics.
All that said, you’re right. Rising inflation can be fought with higher interest rates, and presumably a few quarters of higher interest rates would fix people’s expectations. However, potentially putting more people out of jobs in the short run by raising interest rates would likely be much more difficult to reverse.
Gold prices, like $140 a barrel oil futures prices, are a reflection of too much money in the hands of the wealthy, not of inflation. This is where the $1.5 trillion in tax cuts that Bush pushed through the Senate via reconcilation has gone.
There will be no economic recovery until the Fed DOES TIGHTEN.
Enough slack yields low and stable inflation.
Really? Ever heard of stagflation? Ever seen crises in developing countries? I thought “Freakonomics” is supposed to rely on facts, not on what textbooks say.
WHAT IF…THE FEDERAL RESERV SYSTEM IS ELIMINATED, ON THE BASES THAT IS NOT PERFORMING THE TWO PRINCIPAL REAZONS OF ITS EXISTENCE, THAT IS : JOB CREATION AND STABLE MONETARY DOLLAR. THE DOLLAR IS DEVALUATED FOR PRINTING TO MUCH PAPER MONEY AND UNEMPLOYMENT IS DOUBLE DIGIT. THE CITIZEN OF THE US. DESERVE AN EXPLANATION FROM THE CHAIRMAN OF TE BOARD OF THE FED. BEN SHOLOM BERNANKE. DID THIS MAN MADE HIS TESSIS ABOUT THE ECONOMIC DEPRESION OF THE 1930? THIS GENTLEMAN NEEDS ADVISE FROM POUL VOLCKER AND ALAN GREENSPAN. Jose Gomez Rodriguez. Freelance Think Tank.
Even at an interest rate of zero, the Fed can choose to tax bank reserves (pay negative interest). This and other techniques are known and have been discussed by Bernanke, Mishkin, Woodford, Svensson, etc. Why we needed the stimulus when the Fed didn’t exhaust standard monetary opportunities and (in Fall 2008) and sterilized their interest policy by choosing to pay banks interest on reserves will forever remain a mystery. The latter policy should be reversed today and the banks should be pushed to lend.
In contrast, both the timing and nature of the fiscal stimulus is so contrary to even the most orthodox Keynesian theory (too much long term stimulus, too political, too targeted to low unemployment states, too slow to be spent) that I’m amazed anyone at Chicago could have preferred it over a more expansive Fed in 2008 and 2009.
Your Name Required
Your E-mail Required, will not be published
XHTML: You can use these tags: <a href="" title=""> <abbr title=""> <acronym title=""> <b> <blockquote cite=""> <cite> <code> <del datetime=""> <em> <i> <q cite=""> <strike> <strong>
Your CommentComments are moderated and generally will be posted if they are on-topic and not abusive. For more information, please see our Comments FAQ.
Levitt recently gave a lecture at DePauw University; a writeup can be found here. And here's an interview Dubner did with BookPage about SuperFreakonomics, which enters its second month on The N.Y. Times best-seller list and remains the country's best-selling business book, as ranked by the Wall Street Journal. Meanwhile, Freakonomics has been named one of the best books of the decade by The Onion's A.V. Club, the Times (U.K.) and the Telegraph. Get your book autographed. Sign Up for the Freakonomics E-Mail List. Freakonomics, Live and in Person. About Freakonomics
Stephen J. Dubner is an author and journalist who lives in New York City.
Bio | Contact | Lectures
Steven D. Levitt is a professor of economics at the University of Chicago.
Bio | Contact | Lectures
Their book Freakonomics has sold 4 million copies worldwide. Their followup, SuperFreakonomics, has recently been released. This blog, begun in 2005, is meant to keep the conversation going. Recurring guest bloggers include Ian Ayres, Robin Goldstein, Daniel Hamermesh, Andrew W. Lo, Eric Morris, Sudhir Venkatesh, and Justin Wolfers.
Annika Mengisen is the site editor.
Shopsin's (120 Essex Street) is a New York institution, a restaurant that began as a grocery store; its owner, Kenny Shopsin, is colorful, irascible, and talented. Shopsin's is famous for breakfast but also for its vast, unusual, common-sense menu. Shopsin has just written a book that is half cookbook and half memoir, entirely fascinating. I had never sat down and read a cookbook from cover to cover but that is what happened with Shopsin's book (co-written with Carolynn Carreno). It is called Eat Me. The introduction is a reprint of a New Yorker article by Calvin (Bud) Trillin, a Shopsin's regular. If you do go to the restaurant, do pay attention to Shopsin's idiosyncrasies, because he allegedly has a Soup-Nazi-like intolerance that may earn you permanent exile from his restaurant. (SJD)
I recently took the kids to see a performance by Jim Dale, the longtime British stage actor (he won a Tony for Barnum) who is best known these days as the wildly entertaining reader of the Harry Potter books on tape. He was reading an adaptation of a Eudora Welty story called "The Shoe Bird," which he recently recorded with the Seattle Symphony. (It was wonderful, and I encourage you to give it a listen.) Afterward, Dale took questions from the audience -- which, predictably, were about the Harry Potter series. Items of interest that emerged: Dale was given only 100 pages of manuscript at a time to read and then record, so he never knew what was coming; and in order to keep track of the 146 voices he'd created for all the characters, he often pre-recorded a bit of the characters' voices and then held a tape recorder up to his ear in the studio to remind himself. (SJD)
If you live in or are visiting New York and have children, do everything you can to take in one of the Young People's Concerts at the New York Philharmonic. Even if you don't love the music on that day's program -- we recently attended "Ravel's Paris," not my favorite by a long shot -- all the extras in the program are terrific: the dancers, composers, instrumentalists, and explainers who are paraded out by conductor Delta David Gier to put the music in context for the kids. (SJD)
December 02 (11)
There's a strange view out there that with unemployment above ten percent, and inflation nascent, the Fed should be thinking about raising interest rates. Yesterday Philadelphia Fed President Charles Plosser attempted to explain his view:
December 02 (5)
Gautam Naik provides an interesting and cleverly written piece on the search for a biological basis of violent behavior.
December 02 (25)
The psychologist Barry Schwartz's book The Paradox of Choice (here's his TED talk on the topic) was, for me at least, very persuasive. It made a compelling if counterintuitive argument: even though many people (economists especially) argue that more choice is almost always a good thing, Schwartz argued that too much choice is actually a bad thing, causing decision paralysis and unhappiness.
December 02 (4)
A Boston Globe article explains how "positive deviance" - a way to change behavior by using "nudges" that already exist in a community, rather than imposing them from the outside - substantially decreased malnutrition in a Vienamese village: researchers observed children who looked more nourished than others, found that their families were feeding them crabs - considered a low-class food - and encouraged neighbors to follow the family's good example.
December 01 (18)
A lot of industries are obviously weather-dependent - agriculture, tourism, etc. - but I hadn't known that the traditional production of roofing slate in the U.K. was also at the mercy of the weather. Here is but one of many fascinating things you can learn from Simon Winchester's excellent book The Map That Changed the World, about the proto-geologist William Smith:
Twitter-related portmanteaus (twitanteaus?) - users with a million followers, or those who abandon their tweeting.
The money President Obama is planning to spend on the "surge" in Afghanistan could do more good -- and buy more security -- if put to other uses, including education.
Read Full Article »