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Fed's Dudley Regrets Penny-Pinching
William Dudley, the president of the Federal Reserve Bank of New York, gave a speech on Monday to the National Association for Business Economics, an organization for academic and applied economists. What made the speech particularly remarkable was Dudley did something the Fed almost never does: He disagreed with the consensus opinion of economists.
Dudley said he saw tight money as a major reason for the sluggishness of the economic recovery. "Monetary policy, while highly accommodative by historic standards, may still not have been sufficiently accommodative given the economic circumstances," Dudley said. In adding it to a roster of conventional explanations -- such as the natural consequence of recovering from a financial crisis and fighting global economic headwinds -- Dudley stepped out of line with the vast majority of his fellow economists.
In a recent Economist poll of top U.S. economists, a majority said that monetary policy was "not important" to answering the question of why the recovery has been slow. Less than 10 percent of economists saw it as "very important." Many of the surveyed are members of the NABE, perhaps even in attendance to hear Dudley tell them they're wrong.
In more normal times -- and even through this crisis and the recovery -- the Fed is a preternaturally cautious animal, inclined towards stability, predictability and agreement. When it changes course, it usually does so only after it has secured wide support for the shift.
That makes Dudley's front-running of the consensus very much out of the ordinary, especially because as the head of the New York Fed, he has a permanent seat on the Federal Open Market Committee, which determines monetary policy. Though calls for a new approach to monetary policy have dominated the economics community's blog conversations, that is not at all true offline. You're wrong if you think that the decision to do a third round of bond-buying, let alone its form, was consistent with normal Fed behavior.
Dudley's speech is all the more important because it fleshes out the Fed's rationale for QE3, which follows from the view that monetary policy has been restricting the recovery. Underlying the Fed's actions is a distinctly new philosophy about the state of the economy -- one that characterizes the recovery as persistently and unacceptably weak. Whereas the first two policy interventions came in response to one or two quarters' worth of weak economic data, the Fed's latest answers are for three years of disappointment in unemployment, hiring and gross-domestic-product growth.
The Fed isn't hoping to keep the recovery on track. It wants to put the recovery on a faster one.
One way to think about the difference is in respect to the growth in private payrolls. During the recovery, monthly growth bounced up and down -- and when the downward swings had been pronounced enough, the Fed used it as reason to ease monetary policy.
That is no longer how things are going to work. Now the goal is a large and sustained push to labor markets -- enough that, by one metric, it shifts the year-over-year growth in private payrolls toward 200,000 or even 250,000 jobs per month, instead of the current equilibrium of 150,000.
There’s a fundamental problem, however, with the Fed’s focus on “sustained improvement in labor market conditions.” Though monetary policy can certainly affect unemployment and hiring in the short run, it simply can’t in the long run, as they are what economists call “real” variables. While the Fed’s newfound determination to strengthen, rather than restrain, the economic recovery is welcome news, it should articulate its goal in nominal terms. There’s every reason to think we’ll see real improvements from a nominal goal, but there’s no reason for the Fed to make promises it can’t ultimately keep in the long run.
Nor was the speech a full mea culpa. Dudley took no responsibility for the downturn itself in the way that Chairman Ben Bernanke famously blamed the Fed for the Great Depression. His other explanations for the weak recovery, moreover, put him safely in agreement with most economists.
Dudley's speech shows that behind the Fed’s goal lies a profound change of heart. Let's see if the consensus opinion of economists will follow.
(Evan Soltas is a contributor to the Ticker. Follow him on Twitter.)
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