Scott Sumner indicts the Fed for slow growth, high unemployment


It’s one thing to say that the Fed understands and accepts that without real action and policy commitment, real GDP growth will be slow and the unemployment rate will remain high. That would be an intellectually legitimate, though I think economically inappropriate, course for policy, especially if the marginal cost of NGDP growth at this point is perceived as high. It’s another thing to pretend that the sun is coming out tomorrow, use that as a pretense for no further action, and then dodge responsibility when the real economy fails to improve. What the Fed has done for the last three years makes a mockery of central bank credibility and accountability and avoids true consideration of policy required to meet the dual mandate.

Scott Sumner is the most widely read market monetarist today, and as best I can tell, his NGDP-level targeting monetary policy is gaining supporters (Paul Krugman is not on board yet:-) Recently Scott wrote the following indictment of Fed policy failures. Do you see any flaws in his argument?

(…) I get very frustrated for a number of reasons.  I may be wrong in my outrage, but I’d like people to explain to me why I’m wrong:

1.  We know that in the past the Fed has done great harm to the country.  And we know from the Fed minutes that at times they’ve done this knowingly.  They’ve refused to change course after a bad decision for fear of losing face.  They’ve admitted as much.

2.  We know that the Fed generally does what the consensus of economists think they should be doing.  This means the consensus of economists will virtually never blame the Fed for economic disasters in ‘real time.’  Yes, decades later they’ll blame the Fed for the Great Depression, or the Great Inflation.  But they are supportive of policy in real time, because it’s basically their policy.

3. We know that the Fed takes credit for successes like the Great Moderation.  But that can mean one thing, and one thing only.  The Fed drives NGDP over time.  If the Fed can’t drive NGDP over time, they have no mechanism for creating a ‘Great Moderation.’

4.  We also know that the Fed NEVER, EVER, regards any (undesirable) negative demand shock as being caused by tight money.  Never.  And they provide no metric for us to look at in order to tell how well they are doing.  They talk as if any unfortunate move in NGDP is some sort of act of nature.  Even when (as in 2007-08) it was accompanied by a sudden halt in the growth of the monetary base.  Or when (as in late 2008) it was accompanied by a huge surge in real interest rates on safe government bonds.  Nope, it’s never tight money.  Because that would mean they’d made a mistake.  Not cutting interest rates two days after Lehman failed?  Why would that have been a mistake?  In good times they do produce clear metrics, ways of holding the Fed accountable.  As in 2003 when Bernanke said that NGDP growth and inflation are the only reliable indicators of the stance of monetary policy.  But those metrics are no longer operative when the Fed fails.

5.  We know that the Fed strongly discourages harsh criticism from within.  I’ve personally heard several reports from insiders that testify to a climate of fear. They should be encouraging dissent.  Bernanke should open every meeting asking why there aren’t more Beckworths and Hendricksons and Sumners within the Fed.

6.  We know that American economists as a group mocked the BOJ for their absurd claim that they were unable to boost inflation, at a time when inflation ran a fraction of a percent below the BOJ’s 0% target and unemployment in Japan was a couple percent above the normal level (for either structural or cyclical reasons.) We also know that American economists as a group have not been particularly critical of the Fed, despite inflation running 0.9% below their 2% target over the past 4 years and despite unemployment being far above the historical norm (for either structural or cyclical reasons.)  A transparently obvious double standard. And yet most American economists meekly assert that the Fed has done all it could.

7.  We know that the slowest growth in NGDP since Herbert Hoover would be expected to cause massive unemployment, above and beyond any that occurs for structural (housing) reasons.

8.  We know the Fed could have prevented that drop in NGDP, or at the very least reversed it far more aggressively than it did.

9.  We know that the unemployment triggered by the fall in NGDP has led to hundreds of thousands of babies never being born.

10.  Someone sent me the following from Milton Friedman:

Friedman (1970) wrote:

[I]t was believed [in the Depression] … that monetary policy had been tried and had been found wanting.  In part that view reflected the natural tendency for the monetary authorities to blame other forces for the terrible economic events that were occurring.  The people who run monetary policy are human beings, even as you and I, and a common human characteristic is that if anything bad happens it is somebody else’s fault.

In the course of collaborating on a book on the monetary history of the United States, I had the dismal task of reading through 50 years of annual reports of the Federal Reserve Board. The only element that lightened that dreary task was the cyclical oscillation in the power attributed to monetary policy by the system. In good years, the report would read ‘thanks to the excellent monetary policy of the Federal Reserve…’  In bad years the report would read ‘Despite the excellent policy of the Federal Reserve…’, and it would go on to point out that monetary policy really was, after all, very weak and other forces so much stronger.

[snip – snip]

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