The Cost-Benefit Challenge

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August 24, 2012

The Cost-Benefit Challenge

In its latest Room for Debate feature, The New York Times poses the question "Should the Fed Risk Inflation to Spur Growth?" Befitting a balanced panel of blogging experts, Mark Thoma (Economist's View) says "yes," John Cochrane (The Grumpy Economist) says "no," and Edward Harrison (Credit Writedowns) says something like "irrelevant question, it's going to do neither."

The whole discussion, naturally, is about differing assessments of the costs and benefits of additional monetary stimulus. Not surprisingly, this was also a theme disclosed in the just released minutes of the July 31'August 1 meeting of the Federal Open Market Committee:

Participants also exchanged views on the likely benefits and costs of a new large-scale asset purchase program. Many participants expected that such a program could provide additional support for the economic recovery both by putting downward pressure on longer-term interest rates and by contributing to easier financial conditions more broadly. In addition, some participants noted that a new program might boost business merits of purchases of Treasury securities relative to agency MBS. However, others questioned the possible efficacy of such a program under present circumstances, and a couple suggested that the effects on economic activity might be transitory. In reviewing the costs that such a program might entail, some participants expressed concerns about the effects of additional asset purchases on trading conditions in markets related to Treasury securities and agency MBS, but others agreed with the staff's analysis showing substantial capacity for additional purchases without disrupting market functioning. Several worried that additional purchases might alter the process of normalizing the Federal Reserve's balance sheet when the time came to begin removing accommodation. A few participants were concerned that an extended period of accommodation or an additional large-scale asset purchase program could increase the risks to financial stability or lead to a rise in longer-term inflation expectations...

The questions about the costs and benefits of any particular policy intervention are abundant, and for virtually every potential pro there is a potential con. Here is my personal, certainly incomplete list of pros/cons or benefits/costs associated with another round of large-scale asset purchases:

Pro:	Lower interest rates (and perhaps a lower dollar) will on balance spur spending.
Con:	The expectation of low interest rates for a longer period of time will reduce the urgency to borrow and spend.
Pro:	Expanded asset purchases and lower rates will preserve needed liquidity in financial markets.
Con:	Expanded asset purchases and lower rates will create or exacerbate financial market distortions.
Pro:	More monetary stimulus reduces the probability of an undesirable disinflation in the near term.
Con:	More monetary stimulus increases the probability of undesirable inflationary pressures in the longer term.
Pro:	Lower Treasury and MBS rates will induce an appetite for risk taking that is needed to get productive resources "off the sidelines."
Con:	Lower Treasury and MBS rates will induce an appetite for risk taking that sets us up for the next bubble.
Pro:	Monetary policy is the only channel of support for the economy, absent new fiscal policies.
Con:	Monetary policy support is relieving the pressure to make needed fiscal reforms that would be much more effective than monetary stimulus.
Pro:	With additional monetary stimulus, GDP growth will be higher and unemployment lower than they would otherwise be, and outcomes may be more consistent with the FOMC's mandate to promote maximum employment.
Con:	With additional monetary stimulus, the exit from monetary stimulus once the economy improves will be more difficult than it would otherwise be, and outcomes may be inconsistent with the FOMC's mandate to achieve price stability.
Pro:	The performance of the economy has not been consistent with the FOMC's mandated objectives.
Con:	The economy is slowly moving in the direction of the FOMC's mandated objectives, and the Fed should "keep its powder dry" in case of further deterioration of the economy.

Many, if not all, of these benefits and costs are familiar, and there has been no shortage of opinions advanced. To some extent, it is inevitable that the weighting of these costs and benefits will be to a large degree judgmental. How one weights the risks associated with continued high rates of unemployment versus the risks of imbalances that may arise from low interest rates, for example, is a subjective thing.

Nonetheless, it would be helpful to frame these subjective judgments with a background of some hard evidence. For example, how much unemployment can we gain for a given quantity of asset purchases (or any other monetary policy option on the table)? What are the likely'or existing'distortions created by low interest rates, and what do we think are the tangible costs associated with those distortions? And so on.

So, here is my challenge question: No matter what your opinion about what should be done, and whether you arrive at a conclusion by casual observation, econometric studies, or historical evidence, what do you think is the best evidence concerning any or all of these costs and benefits?

OK, then. Bloggers blog, commentators comment.

By Dave Altig, executive vice president and research director at the Atlanta Fed

 

August 24, 2012 in Federal Reserve and Monetary Policy, Monetary Policy | Permalink

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Do Firms Have Pricing Power?

« The (Unfortunately?) Consistent Record of the Recovery: Duy and Thoma Respond | Main

August 23, 2012

Do Firms Have Pricing Power?

Here's a question every policymaker would like to know the answer to: How much slack is there in the economy? You know the drill: If there's lots of slack, firms have little power to pass cost increases on to customers. But as the economy approaches full employment, the pricing power of firms strengthens, and cost pressures get more readily passed along. The problem is, there doesn't seem to be any practical consensus about the amount of slack in our economy. To paraphrase a well-known adage widely attributed to Nobel Laureate Ronald Coase, we've been torturing the Phillips Curve, but it isn't talking.

We wondered if businesses might be in a better position to say what kind of pricing power they have. So this month we asked our Business Inflation Panel to weigh in on how they might adjust their prices in the face of a hypothetical, unanticipated increase in costs. Not knowing what kind of cost pressure a firm might respond to, we randomly sorted our panel into two groups'one given a 2 percent cost-increase scenario, and one given a 6 percent cost-increase scenario. Here's what we learned:

On average, firms faced with the 2 percent cost increase were likely to pass about 1.3 percentage points (or 66 percent) to their customers. In the portion of our panel considering the 6 percent cost increase, the average impact on customer prices was 3.8 percentage points (or about 63 percent of the cost increase). So in the aggregate, firms think they can pass about two-thirds of any cost increase through to prices, and that belief holds roughly true whether the cost increase is relatively modest or somewhat large.

We asked a similar question of our panel last October, but the responses we got then indicated that firms held a more conservative view of their pricing power.

Of the firms facing the 2 percent cost-hike scenario last October, only 31 percent said they would pass along most of the cost on to their customers, compared with the 53 percent that said they would do so today (see the chart above).

Likewise, of the panelists asked to consider a 6 percent cost increase, only 37 percent said they would pass most of the increase on to customers last October, compared with 60 percent who said they would do so today (see chart above).

What's behind the reported increase in firms' pricing power since October? Well, we'd be speculating on that point, but one thing that's changed since October is that a smaller proportion of firms are reporting sales levels 'less than normal' (54 percent compared with 64 percent in October). Said another way, firms, in the aggregate are reporting less slack today than they were ten months ago'a finding that aligns with recent results from the NFIB small business survey showing a decrease in the percentage of firms that consider poor sales to be the primary issue they face.

Comparisons across industry groups also suggest that slack may be influencing firms' reported pricing power. Retailers, for example, say they would pass through about 75 percent of a cost increase to their customers, compared with only 64 percent for manufacturers and 60 percent for other firms. At the same time, retailers are reporting that sales and price margins are closer to normal'a sign that their perception of 'slack' is not as great as other firms.

Does the analysis above indicate that firms are running out of slack? Sorry, but we can't quite go that far on the basis of these two surveys. But one thing seems clear'while our panel of businesses says sales levels are still below normal, sales and pricing power are better today than they were last October.

By Mike Bryan, vice president and senior economist;

Laurel Graefe, economic policy analysis specialist;

Nicholas Parker, economic research analyst; and

Kate Rees, economic research analyst, all with the Atlanta Fed

August 23, 2012 in Inflation | Permalink

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The (Unfortunately?) Consistent Record of the Recovery: Duy and Thoma Respond

« The (Unfortunately?) Consistent Record of the Recovery | Main

August 22, 2012

The (Unfortunately?) Consistent Record of the Recovery: Duy and Thoma Respond

Mark Thoma, always generous in linking and reposting our musings here at macroblog, took a look at my last post and read a sense of helpless resignation:

David Altig of the Atlanta Fed argues that "the majority of FOMC participants don't seem to think that the unemployment rate will improve that quickly, but "it is not at all obvious that the pace of the recovery is inconsistent with the FOMC's view of achieving its dual mandate." It sounds as though the Fed has given up -- we've done all that we can, there's nothing more we can do, so we won't even try -- and we're not about to risk even the tiniest bit of inflation to find out if we are wrong (and this is despite assurances from Bernanke and others that the Fed is not out of bullets)...

Tim Duy, whose observations in fact motivated my post, had his own response to my comments:

Altig's calculations make the important assumption that the labor force participation rate holds at 63.7%. This effectively assumes that none of the decline in the labor force participation is cyclical. Instead, it is all structural...

There are really two separate thoughts in these comments. So let me take them in turn, but first recap what I said in the previous post (or at least what I meant to say):

• Stepping back and looking at the data, I am drawn to the conclusion that U.S. economy looks like it has settled into a pattern of something like 2 percent GDP growth with net job creation somewhere around 150,000 payroll jobs per month.


• The unemployment projections published in the FOMC participants.' June Summary of Economic Projections (SEP) would, under certain assumptions, be consistent with annual job growth averaging the 150,000 per month pace we have seen over the past year and a half.

The under certain assumptions caveat is obviously important. To Duy's point, my mapping of the apparent employment trend to the SEP unemployment forecasts does assume a constant labor force participation rate. Multiple macroblog posts this year have offered skepticism about exactly that assumption ( here and here, for example), and any rise in the labor force participation rate will require faster job growth to get the same unemployment rate outcomes. But as far as I know'I think as far as anyone knows' participation will rise only if we get that faster job growth in the first place. My only point was that the SEP unemployment rate submissions in June are not obviously out of line with what appears to be the current trend in job creation.

In fact, I cannot tell you what assumptions underlie the unemployment rate (and growth) projections in the SEP. I can tell you only that these are the outcomes the individual participants view as consistent with "appropriate monetary policy." And that brings us to Mark Thoma's concern that the very slow progress toward higher growth and lower unemployment in the SEP implies that the Fed has "given up, "done all that we can," and "won't even try."

I definitively do not want to leave an impression that this view is implied by the SEP. As I noted in my original post (and duly noted in both the Thoma and Duy responses), the definitions of appropriate monetary policy that condition the individual SEP contributions are not spelled out. Lacking that information, one should not infer that monetary policy is assumed by any one individual as fixed or without influence.

Could it possibly be that an unemployment rate at 7.5 percent and GDP growth of 2.8 percent in 2013 (the more optimistic forecasts in the majority, or the "central tendency" range in the June SEP) are consistent with monetary policy having a nontrivial positive impact on the economy?

Of course monetary policy does not operate in a vacuum. As our boss, Atlanta Fed President Dennis Lockhart, said in a speech yesterday:

Monetary policy can exert a powerful positive influence on an economy, but as Chairman Bernanke has pointed out, monetary policy is not a panacea.

I'm not really aware of any models matched to real-world data that suggest monetary policy actions can (at acceptable cost) quickly and completely overcome all of the shocks and headwinds that may present themselves.

You may believe otherwise'that is, you may believe that, for current circumstances, monetary policy is a panacea. Or, less dramatically, you may believe that more monetary stimulus would surely yield something better than what was implied in the June SEP. Fair enough. But you should not believe that lackluster numbers in the SEP tell you anything about individual FOMC participant's views on the efficacy, desirability, or likelihood of further monetary actions, one way or the other.

By Dave Altig, executive vice president and research director at the Atlanta Fed

August 22, 2012 in Federal Reserve and Monetary Policy, Monetary Policy | Permalink

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The (Unfortunately?) Consistent Record of the Recovery

« Deflation Probabilities on Our Radar Screen | Main

August 17, 2012

The (Unfortunately?) Consistent Record of the Recovery

In his last two posts (here and here), economist Tim Duy has done some yeoman work displaying and discussing the economic context of monetary policy decisions past and prospective. Though Wednesday's self-titled post "Data Dump" focuses on the incoming data as a set-up to the next meeting of the Federal Open Market Committee (FOMC), what strikes me is the consistency of the broad macroeconomic outcomes over the course of the recovery. Gross domestic product (GDP) growth has pretty clearly clocked in at about 2 percent...

...and, looking through the quarterly ups and downs, payroll employment growth has clearly trended near 150,000 jobs per month after a slower start in 2010:

The inflation picture shows more variation...

...but in my view, that sort of variation is why it makes sense to think in terms of medium-term performance. "Medium-term" is more a measure of art than science, and I would concede the point that the recovery as a whole would be on the shorter end of that time frame. Suffice it to say that the pace of price-level growth over the past two and a half years wouldn't contradict the presumption that inflation is pretty close to the FOMC's stated longer-run objective.

Duy looks at this performance and sees pretty clear evidence of failure:

The economy continues to settle into a path that is not consistent with either part of the Fed's dual mandate. Moreover, there are very real downside risks to even a tepid outlook...

This is frustrating. What in the world is the point of making a big claim to affirm the nature of the dual mandate and then subsequently ignore any forecasts that indicate you have no faith the elements of the dual mandate will be met anytime soon?

That complaint is not really about the inflation part of the mandate, but the employment/growth part of it. But if you are willing to accept that employment growth remains on a pace of 150,000 jobs per month'and I see no clear evidence to the contrary'it is not at all obvious that the pace of the recovery is inconsistent with the FOMC's view of achieving its dual mandate. Here, for example, are the central tendency ranges of the unemployment rate projections from the FOMC's June Summary of Economic Projections (SEP) and the employment growth that would be required to meet those objectives (with some important assumptions, such as the labor force participation rate remaining at the current level).

Here is the important statement of conditionality, as described in the SEP document:

The charts show actual values and projections for three economic variables [GDP growth, the unemployment rate, and PCE inflation] based on FOMC participants' individual assessments of appropriate monetary policy.

Under appropriate policy'which pretty clearly means mandate-consistent outcomes'the majority of FOMC participants don't seem to think that the unemployment rate will improve that quickly. And, to my point, it is not clear that the trend in payroll employment is inconsistent with that pace of improvement.

Of course, individual contributors to the SEP may have different assumptions about things like the labor force participation rate. More importantly, the SEP is silent on what, in each contributor's view, constitutes "appropriate policy."

And I am certainly begging the important issues. Would the economy have achieved even the somewhat unspectacular pace of 2 percent GDP growth, 150,000 jobs per month, and average inflation near the long-run objective absent large-scale asset purchases ("QE2"), forward guidance (statements indicating that policy rates are expected to be exceptionally low through at least late 2014), and maturity extension programs ("Operation Twist")? Does "appropriate policy" imply that more must be done to achieve even the modest progress in the unemployment rate implied in my calculations above? And could we have (looking backward) or can we (looking forward) do even better with an even more aggressive approach, as many Fed critics argue?

Good questions, those.

By Dave Altig, executive vice president and research director at the Atlanta Fed

 

August 17, 2012 in Employment, GDP, Inflation | Permalink

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Deflation Probabilities on Our Radar Screen

« How big is the output gap? | Main

August 10, 2012

Deflation Probabilities on Our Radar Screen

In the latest Wall Street Journal Economic Forecasting Survey, conducted August 3'6, economists were asked whether they "expect[ed] the Fed to start another round of large-scale bond buying in 2012?" Sixty-three percent answered yes, and 49 percent expected a program would be announced in September, presumably at the end of the next meeting of the Federal Open Market Committee (FOMC) on September 12'13. Obviously this question is of interest to more than just business economists. For example, at his July 17 testimony before the Senate Committee on Banking, Housing, and Urban Affairs, Sen. Mike Crapo asked Fed Chairman Ben Bernanke whether the FOMC should seriously consider more quantitative easing going forward. As part of his response, the Chairman said that "we would certainly want to react against any increase in deflation risk." The entire video exchange can be viewed at the 52'55 minute mark here.

As part of the Atlanta Fed's Inflation Project, we regularly update probabilities of deflation in the Consumer Price Index (CPI) estimated from Treasury Inflation-Protected Securities (TIPS) prices, described here and here. The basic idea is that a recently issued 5-year TIPS has less "deflation protection" than a 10-year TIPS maturing about the same date as the 5-year TIPS. The yield spread between the 5-year TIPS and 10-year TIPS can be used to help estimate the probability of deflation.

The most recent (August 8) estimate puts the 5-year probability of deflation from early 2012 to early 2017 at around 15 percent. As seen in the figure below this probability is up slightly from May, but only about half the readings of the 5-year (2010'15) deflation probability seen in the late summer and early fall of 2010 and considerably below readings seen during the height of the financial crisis in late 2008 and early 2009.

It is important to note that these deflation probabilities are estimates based on a relatively simple model that uses a number of assumptions that not everyone may agree on. Jens Christensen, Jose Lopez, and Glenn Rudebusch at the Federal Reserve Bank of San Francisco have built an alternative model for estimating deflation probabilities that also uses TIPS yields. At the time of the publication of their paper in 2011, their model's probabilities were somewhat lower than'but highly correlated with'ours.

The TIPS market has a number of features that make inferring both inflation expectations and deflation probabilities from them tricky. Most notably, there are unknown liquidity differences between TIPS and nominal Treasury securities. A more direct way of estimating deflation probabilities'or in fact the entire probability distribution of future CPI inflation'using so-called inflation caps and floors has recently been explored by economists Yuriy Kitsul and Jonathan Wright. Inflation caps and floors are essentially options on the Consumer Price Index. We used the Kitsul and Wright method for constructing the implied probabilities of (annualized) CPI inflation over the next five years. As seen in the figure below, this method implies a 13 percent probability that inflation will be 0 percent or negative on average over the next five years. This probability is about at the midpoint of the range that prevailed between October 2009 and March 2012. (See figure 3, on page 29 of Kitsul and Wright's working paper.)

As Kitsul and Wright explain, the market for inflation caps and floors is still quite small relative to the TIPS market. So the deflation probabilities from their model should be considered suggestive, as should our own.

What's the takeaway from all this? Well, readings from the financial market indicate the likelihood of a sustained deflation is currently about 15 percent, or a bit less. That's up from earlier in the year, but not nearly as high as in 2010.

Should we be concerned about the prospect for deflation in the years ahead? This is obviously an important policy question. But I'm not a policymaker; I merely put up the numbers for you to consider. And, of course, we will continue to follow these indicators closely'as can you. Our deflation probability estimates are updated every Thursday and posted on our Inflation Project.

By Patrick Higgins, an economist in the Atlanta Fed's research department

August 10, 2012 in Deflation, Inflation | Permalink

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How big is the output gap?

« What's to be done? | Main

July 23, 2012

How big is the output gap?

It's fair to say, I think, that the question posed in the title of this blog post is at the heart of any monetary policy debate.

Here's how the discussion went at the June meeting of the Federal Open Market Committee (FOMC):

"Meeting participants again discussed the extent of slack in labor markets. Some participants judged that the unemployment rate was being substantially boosted by structural factors such as mismatches between the skills of unemployed workers and those required for available jobs....One implication of the view that there is relatively little slack is that providing more monetary stimulus would be likely to raise inflation above the Committee's objective. Some other participants acknowledged that structural factors were contributing to unemployment, but said that, in their view, slack remained high and weak aggregate demand was the major reason that the unemployment rate was still elevated. These participants cited a range of evidence to support their judgment....These arguments imply that slack in labor markets remains considerable and therefore that a reduction in the unemployment rate toward its longer-run normal level would not have much effect on inflation."

If you want more specifics about these contrasting views, you might find recent speeches by some FOMC meeting participants helpful. Jeff Lacker, president of the Federal Reserve Bank of Richmond, is pretty clearly in the "relatively little slack" group:

"It's worth noting...that the effects of unemployment insurance benefits together with the effects of labor market inefficiencies could plausibly account for a quite substantial portion of our elevated unemployment rate. The quantitative estimates of labor market mismatch come from independent methods and datasets and, in principle, measure conceptually distinct inefficiencies. We shouldn't necessarily assume these effects are additive, but combining all three together yields a range of 2.9 to 5.9 percentage points, which is sizable relative to the increase in the total unemployment rate of 5-½ percentage points during the recession."

Vice Chairman Janet Yellen is also pretty clearly on the other side of the debate:

"A critical question for monetary policy is the extent to which these numbers reflect a shortfall from full employment versus a rise in structural unemployment. While the magnitude of structural unemployment is uncertain, I read the evidence as suggesting that the bulk of the rise during the recession was cyclical, not structural in nature.

"Consider...the difference between the actual unemployment rate and the Congressional Budget Office (CBO) estimate of the rate consistent with inflation remaining stable over time...[the] index of the difficulty households perceive in finding jobs...[and the] index of firms' ability to fill jobs....All three measures show similar cyclical movements over the past 20 years, and all now stand at very high levels."

The positions outlined above lay bare why estimates of the output gap command such weight in the discussion of monetary policy'both ends of the FOMC's dual mandate of maximum employment and price stability may run through it. If the output gap is large, that is, if the level of gross domestic product (GDP) is running significantly under potential GDP, the economy is obviously not in a position of maximum employment. And if that is the case, the inflation trend is likely to be headed lower and so the price stability mandate may also be in jeopardy.

Where do I come out in this debate? That isn't important since I don't get a vote. But my boss, Dennis Lockhart does, and he laid out his position in a recent speech to the Mississippi Economic Council.

"I think the output gap'the amount of slack in the economy'is neither as sizeable as the high-end estimates, nor is it zero. If there were no slack at all, 8.2 percent unemployment would represent full employment. If this were so, the economy would have undergone profound structural change over the last five years. As I weigh the findings of research by Federal Reserve economists and others, I do not think a compelling case has yet been made that structural adjustment has played a dominant role in slowing growth and progress against unemployment.

"If, on the other hand, slack in the economy were close to the high estimates, we should have seen more and more persistent downward pressure on prices and wages than has, in fact, been the case. Deciding on the extent of the output gap is not straightforward. I believe the truth is in the gray middle."

To emphasize, this "gray middle" isn't a compromise but a weighing of the available evidence. If the GDP gap really is close to zero, the profound structural change that the economy ought to have experienced hasn't found great support in the data. But if this is just a bigger version of gaps of recessions past, then where is the great disinflationary pressure such slack would ordinarily imply?

You may have another view and, again quoting Lockhart's recent speech, "reasonable people can consider the issues...and come to different conclusions. "And if you're having trouble getting a grasp on GDP, potential GDP, and why the measurement of our national potential isn't an easy task, perhaps we can help. We've recently produced an educational video on the issue. It's not a deep treatment of the issue'in fact, just the opposite. It's a jumping-in point for those who are interested in the policy debate but haven't a clue what a GDP gap is. As always, let us know what you think.

By Mike Bryan, vice president and senior economist in the research department at the Atlanta Fed

July 23, 2012 in GDP | Permalink

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well, the size of the output gap is mostly beside the point: we *never*, never know the size of the output gap. We didn't in 2007. We didn't in 1998, nor did we know it 1976. Pick a year, we didn't know it that year either.

So whether we know the size of the gap or not should not be relevant, since we've never actually known it. Nor do we know the lags or leads with which monetary policy affects the economy (i say leads, because we know planners set expectations so policy acts with a lead).

The name of the game is not to pick a policy target that corresponds to the size of the output gap, an unknown. The name of the game is to pick a policy that we know will have desirable outcomes *regardless* of the size of the output gap.

Another fact we know is that most people learn on the job. Back in the 90s during the IT boom, most people entering IT did had other backgrounds. Employers in the US generally train employees (even if they have a grad degree). When demand for labor is high enough, employers cant be as picky as they are now. There is no such thing as "structural unemployment" only low demand for labor.

Third, we know that the Federal Reserve cannot target import prices without raising unemployment. 80% of the gap between PCE and GDP deflator is correlated with *oil prices.* You know, the housing market was well into recession in 2008, when the fed left rates at 2% in sept 2008, because it was overly focused on an inflation measure highly influenced by oil prices.

When you add all this up: unknown potential output, weak aggregate demand, and inappropriate measures of domestic inflation, it all adds up to failed policy.

A far better policy over the last 5 years would have been simple nominal income targeting. Had the Fed simply targeted a 4.5% growth path and agreed to steer the nominal economy along that path, we would be in far better shape regardless of the size of the output gap. So-called deleveraging would be proceeding as a far more rapid pace.

Posted by: dwb | July 24, 2012 at 08:28 AM

What's to be done?

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July 13, 2012

What's to be done?

It's always hard to please everyone. Sometimes it's hard to please anyone. You probably don't need a lot of convincing on this point, but if you desire one more case study look no further than the past week's commentary on monetary policy, starting with Wonkblog's rather negative performance review (post by Brad Plumer) of the Fed's recent policy decisions:

"Right now, unemployment is falling more slowly than the Fed expected when it issued its forecasts back in April' When the Fed published its forecasts, it expected more jobs reports like April's, which initially showed the economy adding 115,000 jobs new jobs. But that hasn't happened' Which means the Fed's own numbers prove the Fed is failing to meet its dual mandate of keeping unemployment and inflation low. (Inflation is below the central bank's target right now; unemployment is not.)"

Plumer favorably references an earlier item from the Peterson Institute's Joe Gagnon, bearing the damning title "The Fed Shirks Its Duty":

"On June 20, 2012, the Federal Reserve System's Federal Open Market Committee extinguished the last shred of doubt as to whether it intends to achieve its mandated objectives."

Carnegie Mellon's Alan Meltzer similarly wonders "What's Wrong With the Federal Reserve?" But his lament, published earlier this week in the op-ed pages of the Wall Street Journal, doesn't exactly mesh with the Gagnon-Plumer school of thought.

"One of the Fed's big mistakes is excessive attention to the short term, over which it has little influence'

"The problem with the short term is that data reported today are subject to revision, or reflect only transitory changes. The better economic data last winter are one of many examples. Would the reported improvement in the economy persist? We didn't learn the answer until weaker data reported this spring. Is the slowdown persistent or temporary? We can only guess.

"Executing monetary-policy changes in response to transitory data is a mistake'

"Today's economic problems are serious, but the Fed can't do much about them if these problems are not monetary. Very expansive monetary policies did help during the crisis of 2008'09, but they're not what is needed now'"

I don't see a dispute here about the fact in the first half of the year the U.S. economy has grown considerably slower than most people'including those in the Fed'thought it would. As usual, the dispute comes down to how to interpret those facts and what to do about them.

Material differences of opinion about how to interpret the current economic environment was the focal point of a speech given today by Atlanta Fed President Dennis Lockhart, in Jackson, Mississippi. Acknowledging the divergent views represented by the Plumer, Gagnon, and Meltzer views, President Lockhart offers his own:

"The question that the members of the FOMC confront is whether there is more that can be done to address the related challenges of slower GDP growth and tepid job creation. So, to wind up, let me give you my take on the key questions underlying a decision to bring on more monetary stimulus.

"I think the output gap'the amount of slack in the economy'is neither as sizeable as the high-end estimates, nor is it zero. If there were no slack at all, 8.2 percent unemployment would represent full employment. If this were so, the economy would have undergone profound structural change over the last five years. As I weigh the findings of research by Federal Reserve economists and others, I do not think a compelling case has yet been made that structural adjustment has played a dominant role in slowing growth and progress against unemployment.

"If, on the other hand, slack in the economy were close to the high estimates, we should have seen more and more persistent downward pressure on prices and wages than has, in fact, been the case. Deciding on the extent of the output gap is not straightforward. I believe the truth is in the gray middle.

"On the risk associated with the balance sheet: in my judgment, some further use of the balance sheet to promote continued recovery and/or financial stability brings with it manageable risks. I think reversal of the cumulative balance sheet scale and maturity structure can be accomplished in an orderly manner. But the step of additional balance sheet expansion should be undertaken very judiciously. Such a step would take us further into uncharted territory.

"On the likely effectiveness of further monetary stimulus'a policy that would necessarily be brought to bear at least in part through credit channels'I think we should have modest expectations about what further action can accomplish. I do not think this means monetary policy is impotent or has reached its limit. But I don't see more quantitative easing or similar policy action as a miracle cure, especially absent fixes in policy areas outside the central bank's purview."

And to the dimming forecasts:

"So, as one policymaker, here's my situation: my support for the current stance of policy rests on a forecast that sees a step-up of output and employment growth by year-end and into 2013. If the economy continues on the track indicated by the most recent incoming data and information, that forecast will become untenable, as will the policy premises underlying it."

Plumer and Gagnon argue we are already at that point. Meltzer believes otherwise. Lockhart is weighing both possibilities. That approach pleases neither camp, but it's the right thing to do.

By Dave Altig, executive vice president and research director at the Atlanta Fed

July 13, 2012 in Federal Reserve and Monetary Policy, Forecasts, Monetary Policy | Permalink

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