L-R: inflation hawks, the Federal Reserve Board of Directors, Ben Bernanke
This month my boss, Elizabeth Fenner, did an interview with Charles Evans, head of the Chicago Fed. A lot of it’s about the near future of the economy, but there was something profound in it that you might have missed if you blinked:
Is the Fed willing to risk higher inflation to boost job creation?
Currently, at slightly below 2 percent, inflation is not that big of a problem. As long as unemployment is over 6.5 percent, I would like to keep the federal funds rate where it is. I don’t foresee inflation increasing much above our objective [2 percent]. If it rose substantially above that, say 3 percent, we would seriously consider backtracking.
Evans has been pushing for this for awhile: locking in the federal funds rate (which is very low right now) until unemployment improves to a specific number. In November he discussed this in a speech, explaining the evolution of what’s become known as the “Evans Rule”:
In the past, I have said we should hold the fed funds rate near zero at least as long as the unemployment rate is above 7 percent and as long as inflation is below 3 percent. I now think the 7 percent threshold is too conservative. Our latest actions put us on a better policy path than we had when I first proposed the 7/3 markers a year ago. At the same time, there still are few signs of substantial inflationary pressures. If we continue to have few concerns about inflation along the path to a stronger recovery there would be no reason to undo the positive effects of these policy actions prematurely just because the unemployment rate hits 6.9 percent — a level that is still notably above the rate we associate with maximum employment.
This logic is supported by a number of macro-model simulations I have seen, which indicate that we can keep the funds rate near zero until the unemployment rate hits at least 6-1/2 percent and still generate only minimal inflation risks. Even a 6 percent threshold doesn’t look threatening in many of these scenarios. But for now, I am ready to say that 6-1/2 percent looks like a better unemployment marker than the 7 percent rate I had called for earlier.
So Evans’s goal actually became more liberal as the economy struggled, knocking it down half a percentage point. Anyway, today this happened:
the [Federal Open Market] Committee decided to keep the target range for the federal funds rate at 0 to 1/4 percent and currently anticipates that this exceptionally low range for the federal funds rate will be appropriate at least as long as the unemployment rate remains above 6-1/2 percent, inflation between one and two years ahead is projected to be no more than a half percentage point above the Committee’s 2 percent longer-run goal, and longer-term inflation expectations continue to be well anchored.
In other words, the Evans Rule is now the current policy of the Fed, if a bit more conservative: Evans wanted to start worrying when inflation hit three percent, and the FOMC says it should worry at 2.5 percent.
This may not seem like that big a deal, but it kind of is. Joe Weisenthal of Business Insider calls it a “huge, historic monetary policy statement from the Fed…. This has been a year of incredible evolution for the Fed, and in its final meeting of the year it delivered.” (At the very least, the timing of the Fed’s “aggressively dovish” position is a surprise.)
In recent decades, Fed chairs have spoken about the future in gnomic utterances that require the knowledge of an economist and the close-reading skills of an English major to interpret. There’s a term for it, Fedspeak, which economist Alan Blinder called “a turgid dialect of English,” and that Alan Greenspan calls “the art of constructive ambiguity”:
As Fed chairman, every time I expressed a view, I added or subtracted 10 basis points from the credit market. That was not helpful…. And so you construct what we used to call Fed-speak. I would hypothetically think of a little plate in front of my eyes, which was the Washington Post, the following morning’s headline, and I would catch myself in the middle of a sentence. Then, instead of just stopping, I would continue on resolving the sentence in some obscure way which made it incomprehensible. But nobody was quite sure I wasn’t saying something profound when I wasn’t.
The result was an almost poetically dense prose that required the historical knowledge of an economist and the close-reading skills of an English major to interpret. Or maybe a classics major; earlier this year, Evans memorably contrasted Greenspan’s “Delphic” promises (hints of what the Fed would do couched in “constructive ambiguity") with the idea of “Odyssean promises” (clear, defined goals on monetary policy), in the belief that constructive ambiguity isn’t all that constructive because it doesn’t give businesses any actual confidence in what monetary policy will actually be in the near future.
The Fed isn’t as Delphic as it was under Greenspan, but it still speaks in maths and buzzes like a fridge (like it did today: “‘6.5 percent isn’t a target… it’s a guidepost.’ #parsethat.") For instance, in 2008 the FOMC said that “the Committee anticipates that weak economic conditions are likely to warrant exceptionally low levels of the federal funds rate for some time.”
That’s pretty clear: we’ll make money cheap as long as the economy’s bad. But there’s still no guidance on what “exceptionally low” or “some time” means. A few months later “some time” became “extended period,” which is marginally, amusingly more specific. Then “extended period” became “at least as long as mid-2013,” and later “late 2014,” as the economy continued to sputter and the Fed kicked the can (PDF). So Evans has been pushing the Fed to adapt actual economic goals for when rates would cease being “exceptionally low,” and an actual, narrow range for that term.
Matthew Yglesias calls Evans’s efforts this year in favor of clarity a “low-profile war,” even if it’s couched in the gently careful tones of Federal Reserve bureaucratic gentility:
Evans says that the Fed can guide these long-term expectations in two ways. First, what he calls “Delphic” guidance is a Fed observation that the future economy is likely to be weak and therefore future rates are likely to be low. What he calls “Odyssean” guidance, by contrast, is a Fed promise to keep rates low, giving investors and potential durables goods customers confidence that come what may, the low rate climate will continue into the future. The Fed’s current language is somewhat ambiguous between the two, with formally Delphic statements often receiving Odyssean interpretations in the press and Fed watchers in the media and the business community receiving clear informal guidance that the statements are meant to stimulate the economy.
Evans even gets in a dig: “The punchline is: The FOMC has used forward guidance in the past; and this builds confidence for our macro-policy simulations that use Odyssean forward guidance.” (Get it? I don’t really, either; the setup is a bunch of complex math [PDF].)
And “Delphic” is kind of a Fed snap: “your monetary policy guidance is so opaque, people think you’re a classical priestess whom the historical record suggests was huffing."
Which is a problem for reasons beyond mere clarity. Usually the Fed says something like “we will keep rates low while the economy sucks, for unknown values of ‘low’ and ’sucks.’ Good luck!” It’s not just unclear, it also means the Fed can call backsies. Evans has been pushing particulars and promises, hence “Odyssean.” As Evans writes: “this forward guidance resembles Odysseus commanding his sailors to tie him to the ship’s mast so that he won’t be tempted by the Sirens’ musical calls for an early exit.”
What would tempt the Fed so? Yglesias argues Evans isn’t just changing language, he’s also challenging a philosophy:
Reading between the lines a bit, the main problem experts have with Evans’ proposal is risk-aversion. Policy elites consider the achievement of low and stable inflation since the mid-1980s to be a major achievement and don’t want to do anything that jeopardizes it in any way, even if the cost is a years-long spell of mass unemployment.
Since the Great Recession began, people have been yelling at the Fed about its dual mandate: it’s legally required to address both inflation and unemployment in its monetary policy. As Evans told the Lake Bluff Rotary Club in January, this is unusual for a central bank, making the Fed’s job tricky. Here’s the sort of thing they have to worry about:
Instead of a liquidity trap, some have posited that we are in an economic malaise that reflects “structural factors” (such as a job skills mismatch) and that the economy today is actually functioning close to a new, more dismal productive capacity. I have discussed this very pessimistic “structural impediments scenario” in other forums. If this scenario is true, then further monetary accommodation will only lead to rising inflation without much improvement in unemployment.
It’s sort of like a toilet: if the Fed pulls on the cheap money lever too hard without realizing the economy is plugged up with structural factors, inflation will run all over the floor. Evans didn’t buy the scenario, but couldn’t dismiss it out of hand. There’s some worry about that, actually, the possibility that the pipes could just totally burst. Yglesias again, describing a discussion about Evans’s Odyssean proposal: “Participants included current and former (and perhaps future) officials at the Fed, at international economic agencies, and from the executive branch…. Several people worried that opening the door to even a little bit of inflation would produce uncontrollable price spirals, but nobody could quite explain why.”
The Evans rule clarifies the Fed’s approach to the dual mandate in the near term: it should concentrate on unemployment until it hits 6.5 percent, and shouldn’t worry about inflation until it hits 2.5 percent. Rather than trippy Delphic mutterings about the mandate and the future, Evans suggested Fed emulate a more sober hero of antiquity, and it was (mostly) done.
Photograph: Wikimedia Commons