Evans doctrine gains traction at Fed

Chicago Federal Reserve Bank President Charles Evans takes a question during a round table with the media in Shanghai March 23, 2010. REUTERS/Nir Elias

Once seen as an extreme, even imprudent notion in the corridors of respectable central banking, the idea that a little bit of inflation is needed to let some of the air out of a decades-long debt bubble is gaining ground in establishment economics. Even the U.S. Federal Reserve, a central bank that prides itself in offering a high degree of steady predictability on inflation, is now actively pondering taking more drastic steps, such as linking the path of interest rates to the direction of unemployment or inflation.

One particularly striking passage in minutes to the Fed’s August meeting signaled such an approach was much closer to becoming policy than investors and economists had believed:

In choosing to phrase the outlook for policy in terms of a time horizon, members also considered conditioning the outlook for the level of the federal funds rate on explicit numerical values for the unemployment rate or the inflation rate. Some members argued that doing so would establish greater clarity regarding the Committee’s intentions and its likely reaction to future economic developments, while others raised questions about how an appropriate numerical value might be chosen. No such references were included in the statement for this meeting.

Reuters flagged the theme on Sept. 2 (Fed could get specific on goals if recession hits), just as Chicago Fed President Charles Evans began campaigning for such an approach, which depending on its form might be referred to as price-level targeting. Under such a regime, the Fed would allow inflation to surpass its 2 percent goal for a period, letting it rise to, say, 3 percent, in an effort to stimulate investment and economic activity. Evans argued before the European Economics and Financial Centre in London last week:

We need to take strong action now. Given how truly badly we are doing in meeting our employment mandate, I argue that the Fed should seriously consider actions that would add very significant amounts of policy accommodation. If 5 percent inflation would have our hair on fire, so should 9 percent unemployment. Such further policy accommodation does increase the risk that inflation could rise temporarily above our long-term goal of 2%. I do not think that a temporary period of inflation above 2% is something to regard with horror.

Philly Fed – the nightmare index economists can’t grasp




These are just a few of the (printable) words analysts have used to describe the August release of the Philadelphia Fed’s factory activity index.

And well they might — the Philly Fed has proven to be a nightmare indicator for economists. At -30.7 in August, the index came in far below the consensus forecast for a rise to +3.7 from July’s +3.2. Even the lowest forecast was only -10.

That’s probably one of the worst misses the Reuters polling team can recall in recent memory.

About those low rates … we really really mean it

The Fed this week took the unprecedented step of putting interest rates of virtual permahold for a set period of time — in this case, until the middle of 2013. That’s a long time away, and the promise underscores just how concerned about the central bank is about the U.S. economic outlook. In the short-run, it looked a clever trick, stemming a precipitous slide in global stock markets. (The hint that it might be prepared to take even further action didn’t hurt either). But will the Fed’s doubling-down on its “extended period” pledge work to support a flagging economic recovery when other, stronger unconventional monetary tools have already been deployed to questionable avail?

Many economists think the move is unlikely to have a major impact on growth or the nation’s jobless rate, which has been hovering around 9 percent since the start of the year. A lack of employment prospects, weak consumer demand and a major housing overhang — not high borrowing costs — are the main impediment to economic progress at the moment, they say.  And for that particular ailment, monetary policy has proven an especially blunt tool.

Yet with Washington focused on cutting spending, fiscal policy appears largely off the table. Fed Chairman Ben Bernanke has warned Congress that despite the need for longer-term steps to reduce the U.S. budget deficit, the government should be careful not to cut spending too quickly. Given just how weak U.S. GDP growth has proved this year — economists in a Reuters poll now see 2011 growth at a paltry 1.7 percent — Bernanke may be wishing he had been a little more vocal in urging for a proactive fiscal policy to get the country of the doldrums.

Beige, black and blue

It would have been worse without Canadians, big families and stately homes.

U.S. growth slowed in most parts of the country in June and into mid-July, the Federal Reserve said in its Beige Book survey of economic conditions across the country.

That’s bad news because most economists thought a slowdown in the first half of the year was a temporary soft patch. Weak momentum going into to the second half may point to lingering malaise.

However, there were a few bright spots in the gloom.

In general, consumer spending picked up as lower gas prices gave people more money to spend and made travel less expensive. Retail sales were booming in New York because Canadians, flush with a strong currency, were flocking to one specific large mall in the western part of the state.

Taylor rules were made to be broken

When calibrating monetary policy, central bank officials often turn to the Taylor rule, a useful construct for thinking about the relationship between unemployment and inflation pioneered by John Taylor, former Treasury official and Stanford economics professor. So as the U.S. economy appears to falter and investors begin to speculate on the prospect of another round of monetary stimulus from the Federal Reserve, it’s worth checking in with Taylor’s model.

Economists at Goldman Sachs sought to do just that in a recent research note, and they found something interesting: if one accounts for the effects of unconventional easing through bond purchases as estimated by Fed Chairman Ben Bernanke, then policy is currently as accommodative as it needs to be.

To call for additional easing, these Taylor rules would need 1. much smaller estimates of the effectiveness of asset purchases than cited by Bernanke and/or 2. significant further deterioration in the Fed’s economic outlook.

from The Great Debate:

A great divide holds back the relevance of economists

By Mark Thoma
The opinions expressed are his own.

Reuters invited leading economists to reply to Mark Thoma’s Op-Ed on the “great divide” in economics and will be publishing the responses. Here are responses from Ashwin ParameswaranJames HamiltonDean Baker, Lawrence Summers, and a recap of Paul Krugman’s.

How much confidence would you have in the medical profession if the teaching faculty in medical schools had very little experience actually treating patients, and very little connection to – even a lack of respect for – the practitioners in the field? Would your confidence be improved if medical research had little to do with the questions that are important to the doctors trying to serve patients?

Unfortunately, that's a pretty good description of how economics has been practiced. The questions academic economists are trying to answer have little connection to the problems faced by business economists trying to help their firms make good, profitable decisions (and vice-versa). And though academics pay some attention to government policy, particularly Federal Reserve policy, addressing the problems faced by government economists trying to help policymakers make the best possible choices is not the main focus of this research.

A very British excuse

This time it was the royal wedding. When the economy shrank unexpectedly late last year, it was the bad weather. If Britain’s economy again struggles to generate growth in the current quarter, perhaps it will be blamed on the new series of ‘The Apprentice’.

"Thanks for nothing!"

Britain’s economy grew 0.2 percent quarter-on-quarter between March and June, exactly in-line with the Reuters poll consensus. Perhaps the most interesting part of the GDP release statement was the Office for National Statistics’ claim that without special factors, including the royal wedding, growth could have hit 0.7 percent.

That would have taken the GDP index at market prices back above 100 points – its 2006 base level – for the first time since the recession, but as it happened, it fell just short, at 99.8.

Fed’s Plosser on default risk, inflation, and more

The following are highlights from a Reuters interview with Philadelphia Federal Reserve Bank President Charles Plosser on Wednesday.


“Clearly if something were to happen and financial markets were to seize up, and there were liquidity problems or financial market disruptions, I think the Fed would feel like it had the responsibility to go in and keep markets functioning, as a lender of last resort.”

“We have to be very careful that we don’t become, that we don’t conduct fiscal policy in this context. That we don’t substitute for the inability of the Treasury to borrow in some circumstances. That would be a bad policy decision from my perspective.”

Debt ceiling scuffle already hurting economy

When U.S. President Barack Obama warns about the possible damage to economic growth from a failure to lift the debt ceiling, he usually speaks about it in the future tense. So does Federal Reserve Chairman Ben Bernanke who, when asked about the issue in congressional testimony last week, said “it certainly could slow the economy.”

But as economists at Goldman Sachs see it, that process may already be under way, for the following reasons:

1. Consumer confidence has deteriorated more rapidly in recent weeks than economic variables would suggest.

Give me liberty and give me cash!

Come back Mr Fukuyama, all is forgiven.

In his 1992 book “The End of History and the Last Man”, American political scientist Francis Fukuyama famously argued that all states were moving inexorably towards liberal democracy. His thesis that democracy is the pinnacle of political evolution has since been challenged by the violent eruption of radical Islam as well as the economic success of authoritarian countries such as China and Russia.

Now a study by Russian investment bank Renaissance Capital into the link between economic wealth and democracy seems to back Fukuyama.

Looking at 150 countries and over 60 years of history, RenCap found that countries are likely to become more democratic as they enjoyed rising levels of income with democracy virtually ‘immortal’ in countries with a GDP per capita above $10,000.