Fed Chair Janet Yellen’s speech today on “Inflation Dynamics and Monetary Policy” was long. Including the citation of sources, the appendix, and 35 footnotes, it amounted to nearly 11,000 words (over 11 times as long as this article).
Yet all anyone wanted to hear was confirmation that there would be no rate increase this year, or next year, or ever. You don’t have to give a long speech to explain that.
Those folks were bitterly disappointed when she concluded:
Most FOMC participants, including myself, currently anticipate that achieving these conditions will likely entail an initial increase in the federal funds rate later this year, followed by a gradual pace of tightening thereafter.
So there might be some fireworks in the markets. In case it gets too exciting, she left plenty of wiggle room for some last-minute flip-flopping:
But if the economy surprises us, our judgments about appropriate monetary policy will change.
Yet the most interesting thing in the speech was in the footnotes. There has been pressure building around the world – including some voices at the Fed, at the IMF, and other organs – for boosting the target for consumer price inflation to 4%, and then doing whatever it takes to get there, in a scorched-earth campaign to run over consumers, savers, and the lower 90% of wage earners who’re having trouble getting pay increases.
And investors that hold the $40 trillion in US corporate and government bonds would get their heads handed to them.
But the borrowers would make out like bandits. Over-indebted governments and those lucky individuals with pay increases would see their relative debt burden decrease. Corporations would also see their debt burden decrease. And they’d have the added bonus of being able to show that sales are increasing, rather than shrinking, without having to sell one iota more. It would put an end to the dreary revenue recession that afflicts them now.
Whacky ideas such as raising inflation targets to confiscatory levels have a nasty tendency to acquire a life of their own. So it’s good to see Yellen put the kibosh on them. Here she explains, in her very readable 340-word footnote #14, why this won’t work (paragraph breaks and emphasis are mine):
14. Blanchard, Dell’Ariccia and Mauro (2010), among others, have recently suggested that central banks should consider raising their inflation targets, on the grounds that conditions since the financial crisis have demonstrated that monetary policy is more constrained by the effective lower bound (ELB) on nominal interest rates than was originally estimated. Ball (2013), for example, has proposed 4 percent as a more appropriate target for the FOMC.
While it is certainly true that earlier analyses of ELB costs significantly underestimated the likelihood of severe recessions and slow recoveries of the sort recently experienced in the United States and elsewhere (see Chung and others, 2012), it is also the case that these analyses did not take into account central banks’ ability to use large-scale asset purchases and other unconventional tools to mitigate the costs arising from the ELB constraint.
In addition, it is not obvious that a modestly higher target rate of inflation would have greatly increased the Federal Reserve’s ability to support real activity in the special conditions that prevailed in the wake of the financial crisis, when some of the channels through which lower interest rates stimulate aggregate spending, such as housing construction, were probably attenuated.
Beyond these tactical considerations, however, changing the FOMC’s long-run inflation objective would risk calling into question the FOMC’s commitment to stabilizing inflation at any level because it might lead people to suspect that the target could be changed opportunistically in the future.
If so, then the key benefits of stable inflation expectations discussed below–an increased ability of monetary policy to fight economic downturns without sacrificing price stability–might be lost. Moreover, if the purpose of a higher inflation target is to increase the ability of central banks to deal with the severe recessions that follow financial crises, then a better strategic approach might be to rely on more vigorous supervisory and macroprudential policies to reduce the likelihood of such events.
Finally, targeting inflation in the vicinity of 4 percent or higher would stretch the meaning of “stable prices” in the Federal Reserve Act.
Thank you, Janet!
And here she explains in her unusually personal footnote #28 why raising inflation targeting would be a crummy idea, while admitting that the Fed and other central banks might actually not be omnipotent and that it might take “years” to manipulate the public into the scheme (paragraph breaks and emphasis are mine):
28. My interpretation of the historical evidence is that long-run inflation expectations become anchored at a particular level only after a central bank succeeds in keeping actual inflation near some target level for many years. For that reason, I am somewhat skeptical about the actual effectiveness of any monetary policy that relies primarily on the central bank’s theoretical ability to influence the public’s inflation expectations directly by simply announcing that it will pursue a different inflation goal in the future.
Although such announcements might potentially persuade some financial market participants and professional forecasters to shift their expectations, other members of the public are probably much less likely to do so.
Hence, actual inflation would probably be affected only after the central bank has had sufficient time to concretely demonstrate its sustained commitment and ability to generate a new norm for the average level of inflation and the behavior of monetary policy–a process that might take years, based on U.S. experience.
Consistent with my assessment that announcements alone are not enough, Bernanke and others (1999) found no evidence across a number of countries that the initial disinflation which follows the adoption of inflation targeting is any less costly than disinflations carried out under alternative monetary regimes.
And bond investors are already getting nervous. Read… The US Bond Market is far Larger than the Stock Market: If Even Part of it Blows, it’ll Dig a Magnificent Crater