Narayana Kocherlakota is fast becoming my favourite US central banker (leaving out a number of fed economists like Bob Hetzel who obviously is my main man at the fed…). Here is Kocherlakota:
“Let me turn then to the current stance of monetary policy. Five years ago, in October 2007, the Federal Reserve had under $900 billion of assets, mostly in the form of short-term Treasuries. It was targeting a fed funds rate—the short-term interbank lending rate—of just under 5 percent. Five years later, the Federal Reserve owns nearly $3 trillion of assets, mostly in the form of long-term government-issued or government-backed securities. It plans to buy still more over the remainder of 2012. It has also been targeting a fed funds rate of under a quarter percent for nearly four years—and anticipates continuing to do so through mid-2015. In the language of central banking, the Fed’s policy stance is considerably more accommodative than it was five years ago.
Some observers argue that the Fed has done too much, has been too accommodative. I strongly disagree. These critics are certainly right that the Fed’s actions—tripling its balance sheet and keeping the fed funds rate near zero for years—are historically unprecedented. But it is also clear that the economy has been hit by the worst shock in 80 years. Over the past five years, Americans have lost jobs and a great deal of wealth. Relative to 2007, people remain uncertain about future employment and income. Businesses, too, are less certain about future demand for their goods. These changes and uncertainties make firms and households less willing to spend, and so push down on both employment and prices. In order to fulfill its dual mandate of promoting price stability and promoting maximum employment, the FOMC must offset these adverse shocks by making monetary policy more accommodative.
In light of the unusually large macroeconomic shock, I believe that it is misleading to assess the FOMC’s actions by comparing its current choices to policy steps taken over the past 30 years. Instead, we have to assess monetary policy by comparing the economy’s performance relative to the FOMC’s goals of price stability and maximum employment. In particular, if the FOMC’s policy is too accommodative, that should manifest itself in inflation above the Fed’s target of 2 percent. This has not been true over the past year: Personal consumption expenditure inflation—including food and energy—is running closer to 1.5 percent than the Fed’s target of 2 percent.1
But this comparison using inflation over the past year is at best incomplete. Current monetary policy is typically thought to affect inflation with a one- to two-year lag. This means that we should always judge the appropriateness of current monetary policy using our best possible forecast of inflation, not current inflation. Along those lines, most FOMC participants expect that inflation will remain at or below 2 percent over the next one to two years. Given how high unemployment is expected to remain over the next few years, these inflation forecasts suggest that monetary policy is, if anything, too tight, not too easy.”
I used to think Kocherlakota had no clue about monetary policy. I was obviously completely wrong – Kocherlakota is very clearly one of the most clever fed voices around.
PS Scott Sumner also comments on Kocherlakota.