Thursday, March 20, 2014

Hello Discretion

Today, the much-anticipated first Fed policy statement of the Yellen era came out. FOMC statement, here.

Some interesting tidbits:
The Committee will closely monitor incoming information on economic and financial developments in coming months and will continue its purchases of Treasury and agency mortgage-backed securities, and employ its other policy tools as appropriate, until the outlook for the labor market has improved substantially in a context of price stability. ... asset purchases are not on a preset course, and the Committee's decisions about their pace will remain contingent on the Committee's outlook for the labor market and inflation as well as its assessment of the likely efficacy and costs of such purchases. 
In determining how long to maintain the current 0 to 1/4 percent target range for the federal funds rate, the Committee will assess progress--both realized and expected--toward its objectives of maximum employment and 2 percent inflation. This assessment will take into account a wide range of information, including measures of labor market conditions, indicators of inflation pressures and inflation expectations, and readings on financial developments. 
With the unemployment rate nearing 6-1/2 percent, the Committee has updated its forward guidance. 
In other words, the committee will do whatever it feels like doing, whenever it feels like doing it, based on whatever information it decides is relevant. The Committee updated its forward guidance by throwing it under a bus, or at least by clarifying that it is of the form "here is what we think now we will want to do in the future, but we can change our minds at any time."

The larger context is the debate between commitment or rules and discretion. Discretion wins.

You might expect me to be fulminating. I'm not. (Though I'm waiting for a rules vs. discretion blast from John Taylor! (Update: here it is.)  I regard this as simply stating reality.

Our Fed will operate with complete discretion. On this basis, I was pretty critical two years ago of various proposals that the Fed announce ex-ante that it would keep interest rates lower for longer than it would desire ex-post; to just state some new "rule" or "commitment" that would lower interest rate expectations. I argued, there is no way anyone will believe such a purely voluntary commitment. If it's going to be full discretion, we might as well be upfront about it and stop the charade. Rules where every day is a special exception are not rules. If it's going to be a rule, setting one up requires a lot more than just FOMC statements and "guidance."
Voting against the action was Narayana Kocherlakota, who supported the sixth paragraph, but believed the fifth paragraph weakens the credibility of the Committee's commitment to return inflation to the 2 percent target from below and fosters policy uncertainty that hinders economic activity.
Narayana is always interesting. The fifth and sixth paragraphs are the ones I quoted above. Narayana wants more rules and commitments. But... from the dovish side!  He's worried people don't know the Fed wants more inflation.

But he is right. The problem with full discretion is that it's a lot harder to "anchor" expectations. The Fed is going to dig itself deeper and deeper into this world in which markets hang on every whisper. Maybe full bore discretion isn't such a good idea after all.
 Fiscal policy is restraining economic growth,
This must be a joke. Oh, no, I get it, the Fed has woken up to the growth-sapping effects of high marginal tax rates and a chaotic code. I wish.


  1. Worthwhile to post a prescient paragraph from you two years ago (Sept 24th, 2012 in reference to Woodford at Jackson Hole):

    "Institutions work from historical perspective, and the Fed regards itself as fresh from the great success of "unconventional" policy experimentation in the great crash of 2008. What, tie ourselves to some rule that might keep us from saving the world again with our innovative discretionary policy? Not a chance."

  2. No, the Fed's right: fiscal policy *is* restraining growth. I think any reader here would be very hard pressed to find a convincing case that the US isn't greatly underspending on public infrastructure, which paves the way for growth (pun intentional).

    1. Well I'm a reader, and I definitely don't agree with your final point (if I understand you correctly) that increased government spending on infrastructure creates growth overall. That seems like a Keynesian argument, and in any case ignores the fact that the money the government took (via taxes) to pay the construction workers would have been used by the taxpayers in other ways (creating or maintaining other jobs).

      As for your first contention, that the U.S. isn't spending enough on infrastructure, I submit that is a subjective statement. While it may be true that some bridges and highways are way overdue for repair or replacment, it is also true that much money is being spent on unnecessary highways (and even airports!) and "bridges to nowhere".

    2. First, it's public infrastructure spending is *not* a good proposal necessarily for Keynesian reasons, although there are Keynesian reasons. Public infrastructure is prudent because *it's a public good*.

      Need convincing? Check out the articles below.

  3. "Fiscal policy is restraining economic growth" appeared in the FOMC statement of May 1st, 2013. If it's a joke, shouldn't you have a conjured up a witty riposte by this time?

  4. In other words, "No Rules, Just Right!"

  5. The funny part is that it takes the longest FOMC statement in history to say: "We will exercise our discretion while looking at all the data that comes under our noses."

    1. "And ignoring it at our discretion"

  6. John,

    Would you (and John Taylor) have been happier with the Fed if there statement had read something like:

    "Rule #1 - We won't lend at any interest rate, ever"

    Your obsession with "rules" misses a key point - rules don't make a whole lot of sense unless they are written with a desired outcome. You can argue that discretionary policies lead to bad economic outcomes, but that does not necessarily make rules based policies any better (see Fed rule #1 - no lending).

    From the Fed - "Fiscal policy is restraining economic growth,"

    From you: "This must be a joke. Oh, no, I get it, the Fed has woken up to the growth-sapping effects of high marginal tax rates and a chaotic code."

    You concentrate on the cash flow aspect of tax policy (tax rates) while totally missing the potential for balance sheet effects (tax burden).

  7. Why leave it to John Taylor? Fulminate!

  8. A secret FOMC meeting followed by a blurry policy statement...
    The peevish fixation on inflation persists...

    Meanwhile, institutional real estate investors say Abenomics working in Japan...where, yes, the central bank is targeting higher inflation rates...
    sell USA stocks, buy Japan REITs?

  9. We are becoming more dependent on a group of academics with a spotty track record, but limitless hubris to guide 330 million people into thinking how they want them to think. Not to mention the fed is literally forcing people own assets they think they should own. Why have a market? Below the surface things look dicey economically and we have reliable evidence of the dangers of government debt.. We don't really know what institutions or individuals think about security prices becuase they no longer will express contrarian opinions. All this makes a potential crisis more acute. I've wondering for over a year whether having money outside the US is actually wiser


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