1. Beckworth and Ponnuru argue that the Fed failed to cut interest rates sufficiently in 2007 and 2008 to keep pace with declines in the natural rate of interest. Had they done so, the economy would not have tumbled into recession.
Yet I am not familiar with any natural rate that the federal funds rate was above in 2007 and 2008. Not the estimates from Thomas Laubach and John Williams, nor the ones from Vasco Curdia.
Here is another way to make this point. Take the unemployment rate, inflation, and industrial production. Use those to forecast future interest rates, given current interest rates and recent changes in interest rates. A reasonable measure of the stance of monetary policy would be how the actual interest rate differs from the interest rate you would have expected if asked 12 months ago, had you known the future state of the economy.
By this criterion, the Fed was substantially more accommodative than expected in 2007 and 2008. Only in 2009 and 2010, when an inertial policy rule would have prescribed sharply negative interest rates, was the Fed more accommodative than a simple natural-rate approach would have suggested.
Also, Beckworth and Ponnuru have it wrong on several market measures they cite. Inflation breakevens were flat, not down, in 2007. And the yield on the five-year Treasury, a good measure of future interest rates, was flat, not up, in 2007. As a rebuttal, I would note that longer-term interest rates were above the federal funds rate in 2008. This suggests that investors thought interest rates were temporary low -- and monetary policy temporary accommodative -- until everything fell apart in the fall of 2008.
I dispute that monetary policy passively tightened during this period. If anything, in fact, it looks to me like monetary policymakers took a smart gamble in 2007 and 2008 by easing as much as they did, because economic conditions at the time, and those expected in the future, probably did not justify how low interest rates were during that period. Evidence from natural-rate approaches is inconsistent with Beckworth and Ponnuru's "passive tightening" story.
2. They also suggest that the U.S. economy was weathering the transition from a housing boom well in 2007. I once believed this, but I have changed my mind in the face of evidence from Atif Mian and Amir Sufi. In a 2009 paper, Mian and Sufi showed that:
"[H]ousehold leverage is an early and powerful predictor of the 2007 to 2009 recession. Counties in the U.S. that experienced a large increase in household leverage from 2002 to 2006 showed a sharp relative decline in durable consumption starting in the third quarter of 2006 – a full year before any significant change in unemployment."The recession that followed was simply an intensification of what had begun during the supposed rebalancing. This geographic evidence, too, is inconsistent with Beckworth and Ponnuru's "passive tightening" story.
3. I believe that monetary policy could and should have done more amid the recession, and I have thought and written so for years. Yet I think that Beckworth, Ponnuru, and others like Scott Sumner -- with whom I frequently agree -- are being intellectually dishonest when they say that monetary-policy inaction is the same thing as tightening. You can see that in their words like "cause" and "responsibility."
There is a principled distinction between active and passive tightening in monetary policy. An active tightening is when the central bank raises interest rates with the intention of restricting future economic conditions. A passive tightening is when economic conditions weaken on their own and the central bank does not cut interest rates in response, which means that policy is tighter going forward.
Advocates for activism in monetary policy have a duty to be clear in what we can and cannot expect from central banks. I count reasonable foresight and avoiding passive tightenings among those things. Yet it discredits one's own point of view to say that the Fed causes, or is responsible for, anything to which it does not respond. It an obvious and regrettable case of definition creep.
from Evan Soltas http://ift.tt/205ZRfO Monetary Policy and the Recession - Entrepreneur Generations
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