Marvin, the “confusedfriend”

Marvin Goodfriend has been nominated to the Federal Reserve Board, waiting for Senate confirmation. He comes to the Fed at a critical moment. Critical, because the Fed is in the process of rethinking its monetary policy framework. As Ben Bernanke said in a recent gathering at the Brookings Institution:

Former Federal Reserve Chairman Ben Bernanke predicted that the central bank’s new leadership will study alternate regimes for monetary policy over the next year to 18 months.

“There will be some pretty serious discussions” on policy frameworks at the Fed under the chairmanship of Jerome Powell, Bernanke said Monday. He said Powell is likely to assign a subcommittee of officials to study the subject. “I imagine this will come up for serious debate in the next year to 18 months.”

What sort of contribution is Marvin Goodfriend likely to make?

Over the past several years, Goodfriend has argued that the Fed should focus exclusively on price stability (inflation targeting). He belonged to the group that was worried about runaway inflation back in 2009!

June 24 2009

PREWITT: Well, when you look at interest rates about as low as they have ever been, and you – certainly no increase expected to be announced this afternoon, what about inflation expectations?

GOODFRIEND: They still remain anchored as far as we can see. But the problem is the Fed has not articulated yet its exit strategy. And the exit strategy is what people are looking to, to remain confident that inflation will remain low over the next few years. And that’s what I think the Fed ought to be doing, is articulating an exit strategy so that it gets ahead of a potential weakening of that expected inflation anchor. So far, the Fed has not done that, and I really wish it would.

Shortly after this interview, James Surowiecki wrote a scathing piece in the New Yorker with the title “Inflated Fears”:

The economy is still limping, job losses are still rising, and consumers are still reluctant to open their wallets. So it’s the perfect time to worry about . . . inflation?

Apparently so, because, of late, the cries of inflation hawks have grown increasingly loud. Pointing to huge deficit spending, and to the flood of money that the Federal Reserve has sluiced into the economy, they argue that we’re at serious risk of “igniting out-of-control inflation” and bringing about the collapse of the dollar.

Unless the Fed starts slowing things down, they say, we’ll face price jumps that qualify as “hyperinflationary” (a word that Senator Charles Grassley, the Iowa Republican, actually used the other week). Most Americans are worrying about keeping their jobs. Now we have to worry about becoming Zimbabwe, too.

Two years later, Goodfriend´s mind had not changed.

July 5 2011 Interview with Jon Hilsenrath

JH: We’ve had two inflation scares in the past four years, one in the summer of 2008 and the other in the past few months. Do you think this is becoming a more permanent feature of the economic landscape?

Goodfriend: Yes. Inflation scare concerns are likely to recur and become more severe. We have huge federal deficits in the United States with the potential for inflationary finance in the future.

The low imported inflation from China and other emerging markets is likely to dissipate over time as wages rise in China. And the Chinese yuan and other emerging market currencies are likely to appreciate over time against the dollar.

We’ve got a high unemployment rate, which makes it hard for the Fed to move preemptively against inflation. And we have negative short-term real interest rates.

If you take the near zero short rates and subtract a measure of the current rate of inflation, you get a negative real short term interest rate of 2% to 3%. Even during the Great Inflation period of the 1970s we rarely had real short term interest rates as negative for as long as we have them now.

It is going to be hard for the Fed to dig out of its low interest rate policy with unemployment still high. They’re going to have to begin to move rates up fairly soon to hold the line on trend inflation. All of these reasons make me think that the inflation scare problem is likely to be here for a while, and become more intense from time to time.

JH: A lot of people are going to read this and say, “Is this guy crazy. We have 9% unemployment. There is so much slack in the domestic economy. The economy is barely growing. Where on earth is inflation to come from in this environment?”

Goodfriend: First of all, the fact that core inflation in particular has been rising of late indicates that the scope for easy money to act against unemployment is limited at this point.

Secondly, there is absolutely no reason to allow for persistently higher trend inflation and the inflation scares that will follow. The Fed needs to restore positive real short-term interest rates fairly soon. Otherwise higher trend inflation and inflation scares will force the Fed in the future to more than reverse any short-run gains in employment that it might otherwise achieve in the present.

Four years later, in 2015, he was worried that the Fed did not have credibility against deflation!

In “Monetary Policy Lessons from the 1990s for today”:

The Fed has argued that the shortfall of core PCE inflation relative to its target will be reversed over time because inflation expectations and trend inflation have been well anchored since the mid-1990s.

That presumption is questionable. The Fed’s hard-won credibility in the early 1990s only anchored expectations securely against inflation. Credibility against inflation does not translate to credibility against deflation when interest rate policy is immobilized at the zero bound.

In the absence of Fed credibility against deflation, persistently low inflation may well drag expected inflation and trend 5 inflation below 2%, just as persistently high inflation dragged trend inflation upward— when the Fed lacked credibility against inflation—during the Great Inflation.

The Fed and others have argued from the “bottom up” on a case-by-case basis that the shortfall of inflation today is also likely to be reversed because many relative prices in the index appear to be temporarily low.

One should be suspicious of such “nonmonetary” explanations of inflation given the evidence—like that from monetary policy in the 1990s—that inflation dynamics are heavily influenced by central bank behavior as perceived by the public.

On balance, there is good reason to be skeptical of arguments such as these that low inflation will revert to 2% of its own accord. We are left with two opposing lessons from the 1990s for monetary policy today.

One teaches that failure to raise interest rates in a timely manner risks higher inflation, an inflation scare in bond rates, excessive appreciation of asset prices, or overshooting the sustainable growth path as in the late 1990s.

The other teaches that raising interest rates too far, too soon before the Fed secures its credibility against deflation, risks a “deflationary destabilization” of trend inflation and inflation expectations.

My take on Goodfriend at the FOMC is that he´ll push back against changing the monetary framework, fighting to keep the 2% targeting rule. That said, he´ll likely suggest the Fed be much more “active” in the execution to reach the target.

If he could only change his goal from one that focuses exclusively on price stability to one that focuses on the more encompassing nominal stability, the FOMC would gain. Unfortunately, the price stability (inflation targeting) obsession is hard to “cure”.


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