About That Economy That ‘Should Be’
There are those who are calling for James Bullard to be fired. While that might be deserved given recent history, I believe keeping his place at the head of the St. Louis Fed will do the world far more good. To recap, in March Bullard was unequivocal that the Fed must raise rates or risk facing “devastating bubbles.” Just three months later, he now claims that the FOMC should raise rates just once more (by 25 bps) and that’s it.
The reason for his seemingly contradictory assessment is a beauty, in all the familiar ways of muddying:
An older narrative that the bank has been using since the financial crisis ended has now likely outlived its usefulness, and so it is being replaced by a new narrative. The hallmark of the new narrative is to think of medium- and longer-term macroeconomic outcomes in terms of regimes.
By that view, the current “regime” of substandard growth paired with “full employment” can persist for some time, especially as it has apparently replaced the prior regime where recovery meant recovery. This is entirely different than what you or I would call an economic circumstance consistent with basic economic logic. As I wrote earlier today, it’s an academic copout that says the Fed failed without actually saying it. Because it has been seven years and four QE’s, the recovery is just whatever it is. QE works because it works, so whatever we got out of it is recovery.
Three months ago, by inference, Bullard was of the mind that there was still lift off left and likely to be achieved. That would suggest something changed in only those three months. Perhaps it was the completion of the academic, statistical study that now conveys these “regimes” instead of an economy, though I suspect even those on the FOMC can see at least a much greater risk of where all this might be going.
In that respect, what Bullard is actually doing is trying to extricate the Fed from the business of forecasting altogether because he is admitting that they have no idea what is going on in the economy. Janet Yellen in her press conference accompanying the last FOMC policy statement admitted as much, too. In response to a question as to whether the Fed has altered its view of the relationship between GDP and rates, Yellen went into a rambling, dissembling response about the natural rate of interest (as if there was such a thing, and even if there was that anyone could estimate it). But what she said, eventually, was striking in this context of Bullard’s “new” thesis:
And I think all of us are involved in a process of constantly reevaluating where is that neutral rate going and I think what you see is a downward shift in that assessment overtime. The sense that maybe more of what’s causing this neutral rate to be low are factors that are not going to be rapidly disappearing but will be part of the new normal. Now, you still see an assessment that that neutral rate will move up somewhat, but it has been coming down and I think it continues to be marked lower. And it is highly uncertain, for all of the dots.
Since their view of the “neutral rate” is central to monetary policy, their inability to grasp any degree of modeled certainty is a huge problem relating to everything from long run GDP to the full concept of full employment and now the obviously partial concept of trying to claim simultaneously full employment and dramatic downgrades (in long run GDP and the federal funds trajectory). What she is really hinting at is that the Fed may not know what the neutral rate is anymore (again, as if they ever did). Thus, the status quo response is to stop trying to figure it out and devote more time and attention only to the immediate future (smaller parcels of regimes; for Bullard, it is apparently 2.5 year windows rather than trying to forecast and understand complete cycles) where there is (they think) much less uncertainty.
It’s a lot of academic and unnecessarily complicated jargon to simply admit they are stumped; but that is exactly what their models are telling them if only because they refuse to admit other possibilities. Full employment is supposed to mean full employment and all the obvious, open benefits of it, including where GDP would show it. Instead, full employment in this context is leading to the same malaise as has been the case all along. Instead of trying to figure out why, or whether full employment is actually the operative condition (which would make the most sense), they are instead shutting down the inquiry – lest it lead back to the truth that first reared its ugly head in June 2003.
Because the models are more “real” to economists than what is observed, the fact that this is all taking place now is highly significant. As I accuse them of constantly, policymakers are singularly devoted to the economy as it “should be” to the exclusion of what is actually observed; the one described in the regression of ferbus (FRB/US) and the others as if that were more real. What seems to have happened in the past three months is something that they are having great trouble coming to terms with. In other words, the economy that “should be” has been given a dramatic overhaul, and not in any way they had planned or hoped. It adds another element to the conjecture that something serious changed starting last summer.
In my view, then, Bullard’s place is right where he is; helping to define what I truly hope is even the outline of next stage of progress. He has contributed mightily to the growing realization that central bankers have no idea – not just about the economy but even the role of money and monetary policy. Janet Yellen’s press conference was also a big help to that cause, as well. Maybe in the end she will actually contribute something meaningful even though she clearly doesn’t mean it that way, especially as it would be far more helpful if she just came right out and said they have no idea what they are doing or why the world is the way it is. It would have been better had this all been settled as it should have been thirteen years ago, but we can’t go back and it has to start somewhere. Their dissectible confusion and cloudiness is somewhere.