Jackson Hole 2018 – A time-travel

The theme was market power & monetary policy. That was in the minds of monetary policymakers more than 40 years ago, albeit not as a “force” that restrains wages and prices but as a “force” that enhances them.

Today: — Two of the most important economic facts of the last few decades are that more industries are being dominated by a handful of extraordinarily successful companies and that wages, inflation and growth have remained stubbornly low.

Many of the world’s most powerful economic policymakers are now taking seriously the possibility that the first of those facts is a cause of the second — and that the growing concentration of corporate power has confounded the efforts of central banks to keep economies healthy.

1973-74

Burns believed that the labor unions, through their exercise of monopoly power to push up wages, were blocking his attempt to lower inflation and stimulate economic activity.

He attacked the monopoly power of corporations and unions (U.S. Congress, 2/20/73, p. 414, and 8/21/74, p. 219, respectively):

As for excessive power on the part of some of our corporations and our trade unions, I think it is high time we talked about that in a candid way. We will have to step on some toes in the process. But I think the problem is too serious to be handled quietly and politely

. . . . we live in a time when there are abuses of economic power by private groups, and abuses by some of our corporations, and abuses by some of our trade unions.

Then, there was Powell´s speech on doing monetary policy in a changing economy (one where “stars” are always shifting).

At times, I had the feeling that deep down Powell wanted to eradicate, finally, “star-trekking” from the way monetary policy is conducted.

He shows how imprecise “star-trekking” is by way of two examples. The first is “shifting stars and the Great Inflation:

Around 1965, the United States entered a period of high and volatile inflation that ended with inflation in double digits in the early 1980s. Multiple factors, including monetary policy errors, contributed to the Great Inflation. Many researchers have concluded that a key mistake was that monetary policymakers placed too much emphasis on imprecise–and, as it turns out, overly optimistic–real-time estimates of the natural rate of unemployment.

The chart shows the dynamics of inflation during the Great Inflation.

The next chart illustrates the rate of unemployment relative to the real-time estimate of the natural rate. Most of the time unemployment far exceeded the natural rate.

However, current CBO estimates of the natural rate at the time show a drastic revision of natural rate estimates, with unemployment being, much of the time, below the estimate of natural.

The second example covers the late 1990s with Greenspan at the lead.

The second half of the 1990s confronted policymakers with a situation that was in some ways the flipside of that in the Great Inflation. In mid-1996, the unemployment rate was below the natural rate as perceived in real time, and many FOMC participants and others were forecasting growth above the economy’s potential. Sentiment was building on the FOMC to raise the federal funds rate to head off the risk of rising inflation.

The inflation dynamics during the period describes a “flat sea”.

The rate of unemployment remained continuously below the real-time estimates of the natural rate.

Using the CBO´s current measure of the natural rate does not change the picture drastically.

These two examples provide enough reasons for the Fed to ditch the “star-trekking” manner of conducting monetary policy. In the first example, it provides extremely misleading information in real time, which is what matters for monetary policy. In the second example, it indicates that the Fed´s compass, the Phillips Curve, is faulty. If it weren´t for Greenspan´s hunch, where would we be?

But Chairman Greenspan had a hunch that the United States was experiencing the wonders of a “new economy” in which improved productivity growth would allow faster output growth and lower unemployment, without serious inflation risks. Greenspan argued that the FOMC should hold off on rate increases.

In the 1960s-70s, monetary policy, as gauged not by the FF rate but by what was happening to aggregate nominal spending (NGDP) growth, was expansionary. NGDP growth was volatile and showed an upward trend. That´s consistent with the behavior of inflation during the period.

In the 1990s, monetary policy was adequate, keeping NGDP growth stable at the appropriate pace.

In January 2000, Bernanke (with coauthors) wrote an op-ed in the WSJ called “What happens when Greenspan is gone?” In short, to become independent of Greenspan´s “hunches”, Bernanke et al suggested:

On the principle that it is better to fix the roof when skies are sunny, the Fed should announce its intentions to establish a more open policy framework now.

Their preferred framework was inflation targeting, which 12 years later became the “law of the land”.

Greenspan´s implicit framework could be any of

  1. Inflation targeting
  2. Price level targeting, or
  3. NGDP level targeting

An “identification” of which was the “target” during Greenspan´s time had to wait for the crisis, with NGDP level targeting getting the prize!

As soon as Bernanke took over from Greenspan, inflation targeting initially was “unofficially” pursued. The result, following the strong monetary tightening due to the inflation implication of oil shocks, was a big drop in NGDP growth and level.

The panel indicates that monetary policy “rules the cycle”. When the monetary screws are turned unemployment shoots up and inflation shoots down. With that amount of monetary tightening, even oil prices are clobbered!

Unfortunately, even after demonstrating the uselessness of the Fed´s “star-trekking”, Powell reverts to character saying:

“As the most recent FOMC statement indicates, if the strong growth in income and jobs continues, further gradual increases in the target range for the federal funds rate will likely be appropriate”!

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