Aimless call of the day

From Bloomberg:

U.S. Representative Mike Pence, chairman of the House Republican Conference, said he plans to introduce a bill tomorrow that would end the Federal Reserve’s dual mandate, forcing the central bank to focus on inflation.

“It’s time for the Fed to be solely focused on price stability and not the recently announced QE2,” said the 51- year-old lawmaker.

Inflation and inflation expectations are below what the Fed considers consistent with it’s mandate to keep price growth stable.  As a result, even if the Republicans changed the mandate policy wouldn’t change.

In fact, the whole idea of a “dual mandate” is really just pleasant advertising – as the Fed believes that it can only stabilise economic activity insofar as it ensures that the inflation rate is at trend.  In essence, even with a “dual mandate” they continue to respond to demand shocks (and not respond to supply shocks) in a way that is consistent with a “single mandate” to control inflation.

  • Miguel Sanchez

    This isn’t silly at all. The Fed has been bleating that inflation is “too low” yet at the same time they insist that they’re not trying to push it above 2%. Inflation has only been below 2% for the last four months, and soaring fuel prices will soon put an end to that. So the inflation argument is bunk – the real reason they’re printing money is the high unemployment rate, and the feeling that they have to be seen to be doing ‘something’ about it.

  • @Miguel Sanchez

    Here I’d have to disagree. They will want to keep inflation expectations within some range around 2% – and they have been tracking below that for a good number of months:

    http://www.econbrowser.com/archives/2010/11/inflation_fears_1.html

    This is sufficient for them to justify making policy more stimulatory in terms of introducing QE2 – now inflation expectations are back in that range they couldn’t so much justify additional policy on those lines, but they aren’t introducing anything else so that is a mute point.

    QE2 is consistent with their inflation target, so a statement that says they should focus on their target and not QE2 is missing this.

  • Miguel Sanchez

    “They will want to keep inflation expectations within some range around 2% – and they have been tracking below that for a good number of months”

    Depends who you ask. Consumer surveys of inflation expectations have never come within cooee of falling below 2%. Those charts show that professional forecasters expect 2%+ inflation over the long term, and have been revising up their short-term forecasts all through this year. And as for market-based measures, even if we take the lowest one (at 1.6%), we’ve just seen that this can rise by 0.4% in the space of a couple of months if the data turns out a bit better.

    The fact is that inflation has not been significantly different from target to warrant a response – that is, the Fed doesn’t have a fine enough control over the economy to push inflation expectations from 1.6% to 2% and stop it there. This is not like 2008, when the risk of deflation was real – this time we’re talking about inflation that is slightly lower than some arbitrarily-chosen ideal.

    Unemployment, on the other hand, is miles away from target. The Fed have repeatedly said that they don’t think QE can actually do much about this. But because of their dual mandate, they feel obligated to at least give the appearance of doing ‘something’.

    So they print more money, create unwanted inflation, inflame global tensions about FX policy, and put their own independence at risk – and when it all goes wrong, all they’ll be left with is the Nuremburg defence. Better to ditch the pretence of being able to control things that they really can’t.

  • @Miguel Sanchez

    Ultimately, this is all two sides of the same coin. Inflation expectations and core inflation are below target, and the UR differs is from its SR natural rate – given structural and co-ordination issues.

    I cannot see run away inflation and 10% unemployment occurring – we don’t have any massive supply side shock here. As a result, it does seem like a case where the Fed can move some way along its short run Phillips curve – and depending on their credibility, their ability to push unemployment down does exist.

    The 1970s was a case of a supply side shock which was allowed to infect inflation expectations – without such a shock, so in the current environment, I think there is enough justification for QE2. I would be uncertain regarding further policy though, given that inflation expectations are back within a fair margin of error, and given movements in commodity prices and the such.

  • Miguel Sanchez

    “Two sides of a coin” implies that the risks are balanced. They’re not – inflation is a little bit off target, while unemployment is way off target. The dual mandate forces the Fed to put more emphasis on the latter, even if they know there’s little they can do about it. (Failure to act will presumably invoke some form of punishment, most likely some checks on their independence that will leave them with no choice in the matter.)

    I wouldn’t be so sure that there has been “no massive supply side shock”. But even if that were the case, you’re missing half the story. Inflation was on the rise from the mid-1960s; the prevailing wisdom at the time was that the money supply should be increased because the proper role of policy was to limit the downside risks to employment. Governments were already in the habit of accommodating inflation by the time the 1970s oil shocks hit.

  • @Miguel Sanchez

    “Inflation was on the rise from the mid-1960s; the prevailing wisdom at the time was that the money supply should be increased because the proper role of policy was to limit the downside risks to employment. Governments were already in the habit of accommodating inflation by the time the 1970s oil shocks hit.”

    Agreed.

    They also had a weak view of the supply side, and much of the discipline was captured by political short-termism – these factors do not exist anymore.

    I would go as far as saying the risks aren’t balanced – it depends on our assumptions regarding the slope of the short run phillips curve at present. Which also surely depends on our view regarding how much of the unemployment is “structural” in some sense.

  • Miguel Sanchez

    “They also had a weak view of the supply side, and much of the discipline was captured by political short-termism – these factors do not exist anymore.”

    Really? You’re still talking about a short-run Phillips curve – that’s pretty much the 1960s view of the supply side. And if you think QEII wasn’t motivated by political short-termism then you haven’t been paying attention.

    My fear is the dual mandate being used as a Trojan horse: give the Fed a goal that they can’t actually hope to achieve, then use their inevitable ‘failure’ to legislate for more hands-on government control of monetary policy.

  • @Miguel Sanchez

    “Really? You’re still talking about a short-run Phillips curve – that’s pretty much the 1960s view of the supply side. And if you think QEII wasn’t motivated by political short-termism then you haven’t been paying attention.”

    Fair call, was a rough turn of phrase.

    However, in terms of symmetry – if inflation expectations were the same level above the Fed’s implicit target I would assume that we would be pushing for tightening. So why are we treating the downside of inflation any different? The purpose of the Fed targeting inflation is so it can keep the rate of growth in general prices predictable – which surely begs for a symmetric response.

    This in itself tells us that unemployment is “too high” now, as we accept that there is some short-run trade-off between inflation outcomes and unemployment. So the “dual mandate” points the same way.

    Furthermore, the Fed would be likely to say it can’t do anything about unemployment outside of its mandated inflation target – because the trade-off is only a short-run one. Given that, do we really need to believe that there is any difference between their dual target and a single one.

    [Note: I believe there is, in terms of the “tightness” and “credibility” of the target. However, this is a side matter – and one I think we are in agreement about]

    Also, I don’t blame it on political short-termism. It is consistent with Bernanke’s view on how you change policy – I agree that they are doing QEII instead of getting out the helicopter on political grounds, but the direction of action is consistent.

    “My fear is the dual mandate being used as a Trojan horse: give the Fed a goal that they can’t actually hope to achieve, then use their inevitable ‘failure’ to legislate for more hands-on government control of monetary policy.”

    This sort of thing concerns me as well, and is another reason why I prefer the idea of single targets. One instrument, one target.

    But I am not sure that is really what is happening at the moment – the dual mandate isn’t new, and I believe that Fed action is consistent. Unlike NZ, it doesn’t appear that the US public blames the central bank for economic instability, they instead blame Federal govt.